SEC Issues AML Risk Alert for Compliance Issues Related to Suspicious Activity Monitoring and Reporting at Broker-Dealers

The SEC has warned broker-dealers to watch for compliance issues related to suspicious activity monitoring and reporting.

Seeking to improve compliance with federal anti-money laundering (AML) rules and regulations, the Division of Examinations encouraged firms “to review and strengthen their applicable policies, procedures, and internal controls” in an AML risk alert for broker-dealers.

“The SEC encourages broker-dealers to strengthen their policies and procedures for identifying and reporting suspicious activity as examiners have seen that many firms are not fulfilling their obligations under the law,” said Margie Webber, director of regulatory compliance for RegEd. 

The Examination Division has noticed several deficiencies related to broker-dealers’ obligations under the Bank Secrecy Act (BSA), specifically regarding the Financial Crimes Enforcement Network’s (FinCEN’s) AML Program Rule and SAR Rule. Examiners’ findings include the following observations, according to the risk alert issued on March 29.

AML Policies and Procedures

FinCEN’s AML Program Rule requires broker-dealers to establish and implement policies, procedures, and internal controls for identifying and reporting suspicious transactions. “A broker-dealer should look for indicators of illicit activities (generally referred to as “red flags”) and incorporate those red flags into its policies and procedures. Awareness by firm personnel of red flags and how to respond to those red flags, including escalating awareness of the red flags to appropriate firm personnel, will help ensure that a firm is in a position to identify the circumstances that warrant further due diligence and possible reporting,” the SEC explained in its risk alert.

Inadequate policies and procedures for AML

SEC examiners have found that some firms have not established “reasonably designed policies and procedures and internal controls” for identifying and reporting suspicious activity as required. Examiners noted the following examples.

  • No policies or procedures for raising “red flags” for suspicious activities
  • Setting SAR reporting thresholds at amounts “significantly higher” than the $5,000 regulations require
  • Relying on clearing firms to identify and report suspicious transactions in customer accounts

Failure to implement procedures

“Some firms that had reasonably designed written policies and procedures did not implement their procedures adequately and did not conduct adequate due diligence on or report suspicious activity that, per their own procedures, appeared to trigger a SAR filing requirement,” examiners wrote in their risk alert for broker-dealers.

Examples included:

  • Not filing SARs for transactions similar to ones that they previously reported
  • Not monitoring transaction reports and systems for suspicious activity
  • Failing to follow up on red flags that were raised

Suspicious Activity Reporting

The SAR Rule requires a broker-dealer to file a report of any suspicious transaction with FinCEN. The requirement applies to any transaction of $5,000 or more that meets any of the various criteria established by FinCEN, like it seems to be a transaction that the particular customer would not normally be expected to do.

Failure to respond to suspicious activity

“Weak policies, procedures, and internal controls, or the failure to implement existing policies and procedures, ultimately resulted in firms not conducting or documenting adequate due diligence in response to known indicators of suspicious activity especially with respect to activity in low-priced securities, which are particularly susceptible to market manipulation,” examiners wrote.

Examiners also noted that firms failed to act on information within customer accounts like records of liquidations of large volumes of high-risk, low-priced securities or trades of low-priced stock by customers affiliated with the issuer.

Filing inaccurate or incomplete SARs

Some broker-dealers make it difficult for regulators and law enforcement to follow up on suspicious activity by not including transaction-specific details in the SARs that the firm files. Rather, some firms have “filed hundreds of SARs or more containing the same generic boilerplate language, which failed to make clear the true nature of the suspicious activity and the securities involved,” examiners wrote.

Examiners noted the following examples of SARs that contained inaccurate information or lacked sufficient detail on key aspects of the suspicious activity.

  • Failing to include customer-identification information like Social Security numbers
  • Not reporting the liquidation of low-priced securities shortly after they were deposited
  • Not including details of a cyber-intrusion, like time, manner, and method of the incident

Improving AML compliance

“In fulfilling their important AML obligations, broker-dealers play a vital front-line role in assisting regulators and law enforcement in identifying and addressing suspicious activities to prevent our financial systems from being used for criminal purposes,” examiners wrote, in urging broker-dealers to strengthen policies, procedures, and internal controls for identifying and reporting suspicious activities.

“Strong policies, procedures, and internal controls protect broker-dealers and their customers by ensuring that any suspicious activity is quickly identified and properly reported,” RegEd’s Webber said. “Removing improper and illegal trading is key to maintaining the integrity of firms and financial markets.”

RegEd’s Policies and Procedures Management Solution helps broker-dealers comply with their AML obligations and other regulations. It enables comprehensive, end-to-end administration and oversight of all elements of a firm’s policies and procedures through an enterprise workflow, work-process, and task management platform. Broker-dealers can also incorporate AML into their Firm Element Continuing Education Program through RegEd’s learning management technology.

Schedule a consultation to learn more about how RegEd’s compliance solutions enable securities firms to improve efficiency, effectiveness, and transparency across the enterprise.

About RegEd

RegEd is the market-leading provider of RegTech enterprise solutions with relationships with more than 200 enterprise clients, including 80% of the top 25 financial services firms.

Established in 2000 by former regulators, the company is recognized for continuous regulatory technology innovation with solutions hallmarked by workflow-directed processes, data integration, regulatory intelligence, automated validations, business process automation, and compliance dashboards. The aggregate drives the highest levels of operational efficiency and enables our clients to cost-effectively comply with regulations and continuously mitigate risk.

Trusted by the nation’s top financial services firms, RegEd’s proven, holistic approach to RegTech meets firms where they are on the compliance and risk management continuum, scaling as their needs evolve and amplifying the value proposition delivered to clients. For more information, please schedule a consultation.

SEC’s Examination Priorities for 2021 Reflect Continued Concern for Retail Investors

The SEC’s Division of Examinations will continue to emphasize protection for retail investors in the coming year, particularly for seniors and individuals saving for retirement.

The Examination Division will evaluate whether registered investment advisers (RIAs) meet standards of conduct and will examine whether firms appropriately mitigate and disclose conflicts, regulators recently announced in releasing the SEC’s Examination Priorities for 2021. Examiners will also probe sales of retail investment products.

The priorities are a continuation of the SEC’s efforts to protect retail investors. In the fiscal year 2020, the Division of Examinations:

  • Issued more than 2,000 deficiency letters, which prompted many firms to take corrective actions, like by amending compliance policies and procedures or enhancing their disclosures.
  • Ordered firms to return more than $32 million to investors for fees that were improperly calculated and charged.
  • Referred more than 130 cases to the SEC’s Enforcement division, including referrals related to registered investment advisers selecting higher-cost mutual fund share classes for clients when lower-cost options were available; advisers failing to disclose conflicts of interest, and broker-dealers failing to supervise registered representatives who made unsuitable recommendations to retail customers.

“The SEC’s focus on retail investors speaks to the need for education and training for registered representatives, broker-dealers, and investment advisers,” said Margie Webber, director of regulatory compliance for RegEd. 

Firms can protect themselves by addressing the following SEC 2021 examination priorities through compliance action items.

Standards of Conduct

Examiners will focus on compliance with Regulation Best Interest (Reg BI), Form CRS, and whether RIAs have fulfilled their fiduciary duties of care and loyalty. With a compliance date of June 30, 2020, the standards have a “direct impact on the retail investor experience with broker-dealers and RIAs,” the SEC stated in its report on its 2021 examination priorities.

“Your policies and procedures should clearly define what standard applies to any given situation,” Webber said.

Firms and examiners have been adapting to the Reg BI and Form CRS standards since they were adopted in June 2019. In the past year, the SEC has developed new examination approaches for Reg BI and Form CRS “to both promote compliance and inspect firms in both our broker-dealer and investment adviser/investment company programs,” the SEC stated in its priorities report.

The SEC has also communicated with firms about Reg BI and Form CRS, beginning by publishing two risk alerts in April 2020: Examinations that Focus on Compliance with Regulation Best Interest and Examinations that Focus on Compliance with Form CRS. Regulators then shared preliminary observations from their initial examinations at a Roundtable on Regulation Best Interest and Form CRS in October 2020.

Regulation Best Interest

Reg BI requires a broker-dealer to put a retail customer’s interests first when recommending a securities transaction or an investment strategy involving securities. A broker-dealer must meet a four-part standard of conduct that includes obligations for Disclosure, Care, Conflict of Interest, and Compliance.

The SEC says that its initial examinations for compliance with Reg BI showed “that firms generally responded” by updating their written supervisory procedures (WSPs) and conducting training. However, though some firms incorporated specific compliance processes into their WSPs, others “simply restated the standards, but did not provide any meaningful guidance as to how these should be implemented.”

In December, the SEC issued a Statement on Recent and Upcoming Regulation Best Interest Examinations that identified Reg BI components that could be included in future examinations, including how firms consider costs in making a recommendation and the processes firms use to recommend complex products.

And now, per its recently released priorities report, the SEC has advised firms that in 2021 it will also conduct enhanced transaction testing and “will evaluate firm policies and procedures designed to meet additional elements of Regulation Best Interest, the recommendation of rollovers and alternatives considered, complex product recommendations, assessment of costs and reasonably available alternatives, how sales-based fees paid to broker-dealers and representatives impact recommendations, and policies and procedures regarding how broker-dealers identify and address conflicts of interest.”

SEC Commissioner Caroline Crenshaw believes that examination and enforcement data “will illuminate whether the rule is working as promised, or whether changes may be required,” WealthManagement.com reported in an article about the SEC’s plans to assess Reg BI performance, which was based on an interview with Crenshaw.

Form CRS

Form CRS requires broker-dealers and RIAs to give retail investors a brief customer or client relationship summary. “The relationship summary is intended to inform retail investors about: the types of client and customer relationships and services the firm offers; the fees, costs, conflicts of interest, and required standard of conduct associated with those relationships and services; whether the firm and its financial professionals currently have reportable legal or disciplinary history; and how to obtain additional information about the firm.” Firms must also file their relationship summaries with the SEC and post them on their websites.

Firms filed more than 13,000 Form CRSs in the past year, the SEC noted in its report on 2021 examination priorities. The SEC stated, “We saw a wide variety of approaches that firms used to comply with the requirements of Form CRS, and generally observed firms complying with the Form’s requirements. Many firms appeared to make effective use of hyperlinks in their digital Form CRSs. We also observed that many firms are generally avoiding legalese and generic boilerplate language, but we also noted the readability of some Form CRSs could still be improved.

“Some firms did not adequately respond to the Form CRS disciplinary disclosure requirements, an area all firms should ensure they address. In addition, we identified and notified hundreds of firms that they had failed to timely file a Form CRS.”

The SEC will examine broker-dealers and RIAs to assess compliance with Form CRS in 2021.

RIA Fiduciary Duty

The Interpretation Regarding Standard of Conduct for RIAs that the SEC released in 2019 with Reg BI and Form CRS affirmed and clarified aspects of an RIA’s fiduciary duty that comprises duties of care and loyalty to its clients.

In evaluating RIAs for compliance in 2021, SEC examiners will assess, “among other things, whether RIAs provide advice, including whether account or program types continue to be, in the best interests of their clients, based on their clients’ objectives, and eliminate or make full and fair disclosure of all conflicts of interest which might incline RIAs—consciously or unconsciously—to render advice which is not disinterested such that their clients can provide informed consent to the conflict.”

Examiners will also focus on risks associated with fees and expenses, complex products, best execution, and undisclosed or inadequately disclosed, compensation arrangements.

Retail Investments and Sales Practices

In addition to evaluating broker-dealers and RIAs for meeting standards of conduct, the SEC has also prioritized determining whether transactions involving retail investors and advice provided to them are appropriate. Examiners will assess whether firms meet their legal and compliance obligations when providing retail customers access to complex strategies, such as options trading, and complex products in particular. They will also focus “on how firms are complying with the recent changes to the definition of accredited investor when recommending and selling certain private offerings,” according to the 2021 examination priorities report.

RegEd’s Webber suggested that firms address legal and compliance obligations related to retail investors in their education and training programs. She also recommended ensuring that standards, procedures, and solutions for conflicts of interest disclosure are in place.

Examiners are particularly concerned about conflicts of interest that could compromise a broker-dealer’s, RIA’s, or firm’s obligation to act in the best interest of retail investors. So, examiners have prioritized reviewing firms’ disclosures regarding their conflicts of interest, including those related to fees and expenses.

“Fee and compensation-based conflicts of interest may take many forms, including revenue-sharing arrangements between a registered firm and issuers, service providers, and others, and direct or indirect compensation to personnel for executing client transactions,” according to this year’s examination priorities report.

Strengthening Compliance for 2021 and Beyond

Securities firms that address the SEC’s 2021 examination priorities in their education and training programs will strengthen their compliance programs by doing so. Many companies will use technology to comply efficiently.

“The use of technology to facilitate compliance with regulatory requirements (RegTech) has experienced immense growth in recent years,” the SEC wrote, noting that examiners will focus on the implementation and integration of RegTech in firms’ compliance programs to ensure that the technology is configured correctly and used properly. “RegTech, when implemented appropriately, may increase the efficiency of compliance staff, reduce manual processes, and exponentially increase transaction review capabilities.”

As fit-to-purpose tools tailored to the needs of broker-dealers and investment advisers, RegEd’s compliance solutions for securities firms are highly effective as well as cost-efficient. Firms can seamlessly manage all aspects of their compliance programs, reducing risks and costs by automating and streamlining processes. And each solution is configured for optimal performance by RegEd’s implementation experts, who have worked with many of the nation’s largest securities firms.

RegEd’s compliance management platform includes the following solutions (among others).

  • Education and Training Solution Suite – Advanced learning management technology streamlines the creation of a firm’s annual compliance program, simplifies course enrollment, provides access to timely course materials, and efficiently tracks course completion.
  • Policies and Procedures Management Solution – An enterprise workflow, work-process, and task management solution enables comprehensive, end-to-end administration and oversight of all elements of a firm’s policies and procedures.
  • Conflicts of Interest Solution Suite – Automated end-to-end management of request processes, compliance monitoring and exception management associated with conflict of interest policies embeds best practices in a firm’s compliance program. 
  • Outside Business Activities Solution – Centralized, systematized management of OBA disclosures, attestations and amendments reduces review time and facilitates communication on specific requests to speed the decision process.
  • Gifts, Gratuities and Contributions Management Solution – Advanced software ensures that all transactions comply with regulations and firm policy, providing insight into violations, trends, conflicts of interest, reducing the risk of non-compliance.
  • Personal Securities Account Management Solution – Automating the management of personal trading activities delivers extraordinary efficiency and enhances the quality of supervision while dramatically reducing the risk of non-compliance and related consequences.

Schedule a consultation to learn more about how RegEd’s compliance solutions enable securities firms to improve efficiency, effectiveness, and transparency across the enterprise.

For additional ways to strengthen your firm’s compliance program, view our recent webinar on FINRA’s 2021 Examination and Risk Monitoring Program Report.

About RegEd

RegEd is the market-leading provider of RegTech enterprise solutions with relationships with more than 200 enterprise clients, including 80% of the top 25 financial services firms.

Established in 2000 by former regulators, the company is recognized for continuous regulatory technology innovation with solutions hallmarked by workflow-directed processes, data integration, regulatory intelligence, automated validations, business process automation and compliance dashboards. The aggregate drives the highest levels of operational efficiency and enables our clients to cost-effectively comply with regulations and continuously mitigate risk.

Trusted by the nation’s top financial services firms, RegEd’s proven, holistic approach to RegTech meets firms where they are on the compliance and risk management continuum, scaling as their needs evolve and amplifying the value proposition delivered to clients. For more information, please visit www.reged.com.

Form CRS: An Overview of the SEC-Mandated Customer Relationship Summary Due June 30, 2020

About Form CRS

In June 2019, the SEC adopted requirements (SEC Release 34-86032) for registered investment advisers, broker-dealers, and dual-registrants that do business with retail investors to file Form CRS (customer relationship summary). Form CRS is intended to inform retail investors about:

  • The types of client/customer relationships and services the firm offers;
  • Fees, costs, conflicts of interest, and required standard of conduct associated with those relationships and services;
  • Whether the firm and its financial professionals currently have reportable legal or disciplinary history;
  • How to obtain additional information about the firm.

Form CRS applies to registered investment advisers, broker-dealers, and dual registrants that do business with retail investors. See page 189 of SEC Release 34-86032 for the definition specific to Form CRS and more information.

  • For investment advisers, Form CRS is known as Part 3 of Form ADV.
  • For broker-dealers, Form CRS is known as such and has no association with Form BD.
  • Form CRS does not apply to those who do business only with institutional investors.
  • Form CRS is an additional disclosure requirement. It does not eliminate any existing disclosures.
  • Form CRS may be delivered as part of a disclosure packet, but it must be the first document. For example, some investment advisers are considering a disclosure packet approach to include Form ADV Part 2B disclosure supplements.
  • Dual registrants may have particular challenges. For example, if the firm is a dual registrant, but the financial professional engaging with the retail investor is qualified only as a registered representative, it must be made clear in the relationship summary.

The deadline for firms to be compliant with Form CRS is June 30, 2020.

Form CRS is designed to help retail investors better understand the nature of the relationship and what services they can expect from a financial firm and its individual professionals, primarily in terms of a fee-based account with an investment adviser, a transaction-based account with a broker-dealer, and the significance, roles, and duties of an investment advisory representative versus those of a registered representative.

Formatting and presentation instructions are specific (See general instructions for Form CRS).

  • Firms must respond to each item and must provide responses in the same order as the items appear in the instructions.
  • The relationship summary must not exceed the equivalent of two pages, for standalone investment advisers or broker-dealers, or four pages, for dual registrants, using reasonable paper size, font size, and margins. If delivered electronically, the relationship summary must be the equivalent of the paper formatting.
  • The relationship summary should be concise and direct, using short sentences and paragraphs. It  must be written in plain English (see the SEC’s A Plain English Handbook: How to Create Clear SEC Disclosure Documents), taking into consideration retail investors’ level of financial experience. Responses to each item must be written as if speaking to the retail investor, using “you,” “us,” “our firm,” etc. Responses must be factual and provide balanced descriptions to help retail investors evaluate services.
  • White space, charts, graphs, tables, and other graphics design features should be included to make the relationship summary easy to read. For a relationship summary posted on a website or otherwise provided electronically, online tools are encouraged, including links to video or audio messages, mouse-over windows, chat functionality, and hyperlinks to information that enhances a retail investor’s understanding of the material in the relationship summary.
  • Conversation starter questions must be formatted to make them more noticeable and prominent than the standard surrounding text.

Conversation starter questions must be included in Form CRS. They are intended to engage retail investors in a discussion about the differences between an investment adviser and a broker-dealer and their relationship with a financial professional, including legal obligations, conflicts of interest, and reportable disciplinary history. For example:

  • “As a financial professional, do you have any disciplinary history? For what type of conduct?”
  • Firms must answer “yes” or “no” accordingly and, regardless of the answer, refer retail investors to Investor.gov/CRS, for additional information.
  • Firms with disciplinary history should be prepared to answer follow up questions and direct clients to additional information.

Other conversation starter questions pertain to conflicts of interest. (Item 3. Fees, Costs, Conflicts, and Standard of Conduct; see page 550 of SEC Release 34-86032 for more information.) For example:

  • “What are your legal obligations to me when providing recommendations as my broker-dealer or when acting as my investment adviser? How else does your firm make money and what conflicts of interest do you have?”
  • Firms will be required to distinguish firm-level from financial professional–level conflicts.

Initial Filing Requirements

Investment advisers must file Form ADV, Part 3 (Form CRS) electronically through IARD. Broker-dealers must file Form CRS electronically through CRD. Dual registrants are to file both. See page 544 of SEC Release 34-86032 for more information.

IARD and CRD systems should be available to accept filings on May 1, 2020; initial filings must be made no later than June 30, 2020.

Delivery Requirements to Clients

Initially, Form CRS must be delivered to current and prospective retail investor clients within 30 days of the regulatory filing deadline of June 30, 2020.

Investment advisers must send Form CRS to clients and prospective clients before or at the time they enter an investment advisory contract with the retail investor. This includes oral agreements. Broker-dealers must send Form CRS to clients and prospective clients before a recommendation of account type, securities transaction, or a recommendation of investment strategy involving securities is made or before placing an order for a retail investor, whichever is earliest. Dual registrants must send Form CRS in accordance with the earliest triggering event of an investment adviser or a broker-dealer.

Form CRS must be amended or revised and filed with IARD or CRD within 30 days of any information becoming materially inaccurate. Amended or revised versions of Form CRS must be delivered within 60 days of change to each retail investor who is a client or considered a prospect of the firm.

Compliance and Recordkeeping

The SEC may use the information provided in Form CRS to manage its regulatory and examination programs, and firms will need to integrate the relationship summary into their compliance controls, including policies and procedures, supervisory controls, testing, tracking, training, and recordkeeping.

  • Investment advisers must retain copies of each relationship summary and each amendment or revision, and they must retain a record of the dates that each relationship summary and any amendments or revisions were given to any client or prospective client who subsequently becomes a client. Records must be retained for a minimum of five years. (Amends Rule 204-2 of the Investment Advisers Act of 1940.)
  • Broker-dealers must retain a record of the date each relationship summary was provided to each retail investor, including any summary provided before the retail investor opens an account. Records must be maintained for a minimum of six years after the relationship summary is created. (Amends Rule 17a-3 of the Securities Exchange Act of 1934.)
  • Dual registrants must retain records in accordance with which role they adopt as a financial professional.
  • See page 499 of SEC Release 34-86032 for more information.

RegEd is ready to assist investment advisory firms, broker-dealers, and dual registered firms with various compliance issues related to Form CRS, including managing various disclosures, training, versioning, managing client delivery, and more. For further information, schedule a consultation with RegEd representative.

Scroll to top