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U.S. Securities and Exchange Commission

Testimony Concerning
the Financial Aspects of the War on Terrorism and the Implementation of the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001

by Annette L. Nazareth
Director, Division of Market Regulation, U.S. Securities and Exchange Commission

Before the Committee On Banking, Housing and Urban Affairs, United States Senate

January 29, 2002

Chairman Sarbanes, Ranking Member Gramm and Members of the Committee:

I am pleased to appear before you today to testify on behalf of the Securities and Exchange Commission (SEC or Commission) concerning steps the Commission has taken to assist in the financial aspects of U.S. anti-terrorism initiatives, and the implementation of the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 — which is Title III of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (PATRIOT Act).

My appearance before you today comes during a period of close intergovernmental cooperation. The Departments and Agencies represented by those of us testifying on this panel and the other members of government and independent private sector working groups put into place after the horrible attacks of September 11, 2001 are working to implement the PATRIOT Act's new mandates in the fight against money laundering and terrorism. Chairman Pitt has made clear the Commission's full partnership in these efforts. Within hours of the September 11th attacks, the Commission and its staff began the process of identifying and executing the steps we could effectively take in this collaborative effort. The enactment of the PATRIOT Act further strengthened this process.

Financial Aspects of the War on Terrorism

I will first address the SEC's contributions to the financial aspects of the government's anti-terrorism efforts that respond most directly to questions raised by the attacks. There are two key components to this work. First, on September 12, 2001, the staff of the Division of Enforcement commenced a review of certain trading activity preceding the terrorist attacks on September 11th. Working with the surveillance staff of the U.S. securities self-regulatory organizations, Commission staff reviewed trading activity in over 125 individual securities and index products. The results of this inquiry have been, and continue to be, shared with criminal law enforcement authorities.

Second, we have supported the effective use of the "Control List" of individuals or entities identified by the Federal Bureau of Investigation and other law enforcement agencies in their ongoing investigations of the events of September 11th. At the request of the Department of Justice, the Commission issued a release to enlist the voluntary review by securities-related entities of the Control List to identify name matches with accounts at each institution.1 The Commission's release followed meetings among government and private sector representatives working together to uncover financial aspects of the terrorist attacks. To date, the Commission has received nearly 1800 responses to this release and has coordinated the collection of account documentation relevant to these responses. Under what have often been challenging personal and professional circumstances, securities firm personnel have searched their records in order to aid the government's efforts. The cooperative efforts and practices developed through this early work are helpful to us as we consider how to encourage ongoing cooperation among financial institutions and government, as Congress has called for in Section 314 of the PATRIOT Act.

Implementation of the PATRIOT Act for the Securities Industry

We have also taken up the clear mandate Congress gave us in the PATRIOT Act. The Commission is an active participant in working groups, led by the Department of the Treasury (Treasury), that were established to help implement the PATRIOT Act. SEC enforcement and regulatory staff are providing their expertise in support of the working groups' efforts.

Regulatory implementation of the PATRIOT Act is proceeding on time. This progress builds on the strong foundation of pre-existing U.S. financial regulation and anti-money laundering efforts. New regulations, either proposed or soon-to-be proposed, should provide appropriate tools to deny money launderers and terrorists the use of the nation's financial institutions to launder the proceeds of crime for profit, or for the furtherance of their criminal activities, including terrorism.

One important tool is the proposed suspicious activity reporting rule for broker-dealers. Treasury proposed this rule on December 20th, after close consultation with Commission staff. This proposal, which Treasury had underway well before September 11th, was completed shortly after the enactment of the PATRIOT Act. It will require broker-dealers to file with the government reports of suspected illegal activity through their firms. These reports are widely known as SARs.2

SEC and Treasury staff readily reached consensus on extending comparable obligations to file SARs across financial institutions. Treasury's proposal would implement a SAR regime for broker-dealers that closely mirrors existing requirements for depository institutions. In its proposal, Treasury points to the importance of strong compliance procedures and states that, for broker-dealers as for banks, the proposed suspicious transaction reporting requirements require financial institutions to evaluate customer activity and relationships for money laundering risks. The proposed rule focuses broker-dealers on the money laundering risks stemming from their client-base and the types of business in which they engage. For instance, because so little broker-dealer business is done in cash, there is relatively little "placement stage" money laundering risk at broker-dealers.3 Nonetheless, the rule requires broker-dealers to remain vigilant with respect to any cash or cash equivalent business in which they may engage. This risk-based approach to identifying and reporting suspicious transactions should empower broker-dealers to focus their SAR detection and reporting resources appropriately.

As the Committee knows, broker-dealers affiliated with banks have already long been subject to the bank regulators' SAR rules. Other broker-dealers have filed SARs on a voluntary basis. We believe that this rulemaking proposal completes the process of assuring that all broker-dealers report possible money laundering. Moreover, this rulemaking will enable all broker-dealers registered with the Commission to be subject to the same SAR rule. In particular, we expect, as a result of Treasury's consultation with the Board of Governors of the Federal Reserve System, that the bank regulators will determine, once Treasury's broker-dealer rule becomes effective, that bank-affiliated broker-dealers should be subject to Treasury's rule, rather than two separate SAR rules.

Apart from Treasury's proposed SAR rule for broker-dealers, we are also working with the other members of the working groups, including the bank regulators, the Commodity Futures Trading Commission, Department of Justice, and Internal Revenue Service to move forward with the full complement of rules called for under the PATRIOT Act. Significant steps are underway that should increase the information financial institutions have about customers they accept, as well as improve their decisions about whether to engage in certain business at all.

For example, on December 19th, Treasury issued a proposed rule to implement the PATRIOT Act's new prohibition against providing correspondent accounts to foreign shell banks that are not affiliated with a supervised bank.4 Commission staff consulted with Treasury throughout its rule drafting process, providing technical assistance as Treasury considered the scope of accounts that would be considered to be "correspondent accounts." The proposed rule includes procedures designed to aid firms in meeting the challenges of determining whether their customers, or their customers' customers, are foreign shell banks. It also takes a bold step forward in excluding from the American financial system any "brass-plate" bank that blocks official scrutiny of the actors behind it. We look forward to working with Treasury to respond to technical questions received during the notice and comment process on this proposed rule.

Other forthcoming rulemaking projects should complement the shell bank proposal. In particular, interagency discussions are underway concerning the identification of customers at account opening (as required under Section 326 of the PATRIOT Act) and due diligence policies for correspondent and private banking accounts (as required under Section 312). We expect that rule proposals in the coming months under these provisions will direct financial institutions, along with their examiners, to use risk-based approaches to acquiring and assessing information necessary to address money laundering.

Section 352 of the PATRIOT Act also requires financial institutions to establish anti-money laundering programs by April 24, 2002. In order to implement this provision fully and effectively, the National Association of Securities Dealers-Regulation (NASDR) and the New York Stock Exchange (NYSE) have stepped forward to create a regulatory framework. The NASDR and the NYSE developed a rule that was vetted fully through the Section 352 interagency working group. We expect the NASDR to file this proposed rule for Commission consideration shortly. A companion rule is scheduled to be considered by the NYSE Board in February. These proposals by the securities industry's self-regulatory organizations (SROs) will, when completed, enable front-line examiners for broker-dealers, as part of their ongoing responsibilities, to examine and enforce this key provision of the PATRIOT Act.

In addition to its role in these rulemaking efforts, the Commission is continuing in other ways to focus its attention, and the securities industry's attention, on money laundering. Bank Secrecy Act provisions that are applicable to broker-dealers have been included in our examination program for decades.5 In addition, we have long had an open dialogue with a Securities Industry Association-affiliated group of senior broker-dealer compliance officials who meet to share anti-money laundering approaches with one another, and with government.

A current, broader Commission examination initiative was announced in May 2001. Commission staff, along with staff from the NYSE and NASD, began conducting a series of comprehensive risk-based anti-money laundering examinations to assess industry practices for anti-money laundering compliance.6 Preliminary results of the examinations, which have not been completed, support the recent assessment of the U.S. General Accounting Office in its October 2001 report.7 Larger firms, which effect the most securities transactions and hold most of the U.S. market's accounts and assets, have for the most part implemented a broad range of anti-money laundering measures. Middle-sized and small firms, however, have further to go in focusing attention on money laundering risks. The ongoing examinations are helping shape our understanding of existing practices at all types of firms, and of how they should be strengthened.

The working groups established by Treasury to implement the PATRIOT Act also are addressing other mandates of the PATRIOT Act. As mentioned earlier in my testimony, progress has been made in developing a proposal to facilitate the sharing of information between government and financial institutions that may be critical in the fight against terrorism. In addition, interagency groups have had initial discussions regarding the definition of key terms under the PATRIOT Act, including the definition of "concentration accounts" as called for under Section 325. Another group has also begun the analysis of government-wide access to information called for under Section 361.

The SEC staff also has been working with Treasury and the private sector to address the application of the Bank Secrecy Act to investment companies registered with the Commission under the Investment Company Act of 1940. While investment companies have not to-date been directly covered by Bank Secrecy Act regulations, the broker-dealers that sell the funds are covered. Later this year, we expect a broader interagency working group under Section 356 to submit a report concerning regulations to apply the Bank Secrecy Act to registered investment companies along with hedge funds and personal holding companies. In the near term, however, the working group already is addressing the application of Section 352 (anti-money laundering programs) to investment companies. Moreover, as you may know, the Investment Company Institute (ICI) issued a paper entitled Money Laundering Compliance for Mutual Funds in May 1999 in order to focus its members' attention to the money laundering risks they face. Since the enactment of the PATRIOT Act, the ICI has offered its cooperation in extending these provisions to its members.

I am heartened to be able to provide the Committee with so many examples of action taken since the adoption of the PATRIOT Act. Together, the regulators and the industry have made substantial progress on some difficult issues in a short period of time. On behalf of the Commission, I appreciate the opportunity to participate in this hearing. We look forward to continuing to share our views with this Committee, the Treasury and other participants in the implementation of the PATRIOT Act. I am happy to try to respond to any questions the Committee may have.


1 See Securities Exchange Commission Press Release No. 2001-115 (October 18, 2001).

2 66 FR 67670 (December 31, 2001).

3 In the "placement" stage, cash is converted to monetary instruments, such as money orders or travelers checks, or deposited into financial institution accounts. In the "layering" stage, these funds are transferred or moved to other accounts to further obscure their illicit origin. In the "integration" phase, the funds are used to purchase assets in the legitimate economy or to fund further activities. See Anti-Money Laundering: Efforts in the Securities Industry (GAO-02-111, October 2001) and The 2001 National Money Laundering Strategy, prepared by the U.S. Department of Treasury, in consultation with the U.S. Department of Justice (available at www.ustreas.gov/press/releases/docs/ml2001.pdf).

4 66 FR 67460 (December 28, 2001).

5 In addition, because the Commission has incorporated Bank Secrecy Act ("BSA") recordkeeping and reporting requirements into its own rules, the Commission enforces these BSA requirements. See Securities Exchange Act Rule 17a-8.

6 Money Laundering: It's on the SEC's Radar Screen, Remarks by Lori A. Richards at a conference program entitled Anti-Money Laundering Compliance for Broker-Dealers, organized by the Securities Industry Association (May 8, 2001).

7 See supra note 3.



Modified: 01/29/2002