Compliance Issues Related to Suspicious Activity Monitoring and Reporting at Broker-Dealers

The US Securities and Exchange Commission (SEC) Division of Examinations (EXAMS) conducts exams on broker-dealer firms and mutual funds for compliance with Anti-Money Laundering (AML) requirements. On March 29, 2021, the SEC published an alert on areas of concern regarding broker-dealer suspicious activity monitoring and reporting. EXAMS lays out the relevant Bank Secrecy Act (BSA) obligations for broker-dealers, including the AML program and Suspicious Activity Report (SAR) rule requirements, as well as provides specific examples of deficiencies observed as part of its examinations.

AML Policies and Procedures and Internal Controls 

EXAMS observed certain broker-dealers inadequately designed policies, procedures and internal controls to identify and report suspicious activity required under the BSA. Specifically, EXAMS found that:

  1. Certain firms did not include any red flags in their policies and procedures to assist with identifying activity for further review, or failed to include red flags associated with securities transactions. EXAMS also found that, when firms did include red flags in their policies and procedures, they did not tailor them to the risks associated with their products and services. EXAMS cited activity involving low-priced securities, which is associated with market manipulation and pump-and-dump schemes, as an example of a red flag that brokers did not address. 
  2. Firms with large volumes of daily trades failed to form and apply automated systems to monitor and report suspicious activity in connection with large-volume trading. Firms would instead rely on a manual review process of trading and failed to establish procedures or controls designed to spot suspicious patterns or trends across accounts. 
  3. Some firms set the threshold for generating alerts too low for low-priced securities. Certain firms, for example, set alert thresholds under $1 per share, which fails to catch securities priced between $1 and $5 per share. The SEC considers securities priced between $1 and $5 per share to be low-priced or “penny stocks.”
  4. Firms set SAR-reporting thresholds at amounts higher than the $5,000 threshold required by the SAR Rule, which led to the failure to identify and report potentially suspicious activity above $5,000, but below the set threshold. 

EXAMS also found that although certain firms recently designed policies and procedures, they failed to adequately implement them. EXAMS, for example, found that certain firms did not follow up on red flags as documented in procedures or comply with firm prohibitions on accepting trades on low-priced securities.

Suspicious Activity Monitoring and Reporting

EXAMS observed that when firms identified activity involving low-priced securities, market manipulation, or pump-and-dump schemes, firms did not review the activity and/or follow up to consider filing SARs. The following are specific examples of indicators of suspicious activity that firms did not adequately assess: 

  • Large deposits of low-priced securities that were followed by immediate liquidation of those securities shortly after.
  • Trading in thinly traded, low-dollar securities that would result in an unexpected spike in price or that represented most of the securities’ total daily trading volumes.
  • The trading in the stock of issuers that were shell companies, had been subject to trading suspensions, or whose officers or other insiders had a history of securities violations.
  • Questionable background of customers, if they were the subject of criminal, civil, or regulatory actions relating to securities law violations.

Filing Inaccurate or Incomplete SARs

EXAMS observed that broker-dealers in some cases did not include details known to the firm about individual customer trades or did not make use of specific structured data fields on the SAR. Specifically, EXAMS identified hundreds of SARs that contained the same generic “boilerplate” language, making the SARs less valuable to law enforcement. EXAMS also found that several firms filed SARs with inaccurate information or lacked key details about the suspicious activity. Some examples were:

  • Reporting the deposit of low-priced securities but failing to report the liquidation of the same security shortly after and the nature of the proceeds.
  • Not including key information despite having the information available in the firm’s internal records. Examples of key information that was available include Social Security numbers, customers’ disciplinary history, and account numbers and dollar amounts for customers’ losses from identity theft and account  fraud.  

Recent Example Involving GWFS Equities

The SEC recently cited GWFS Equities for inadequate SAR filings, including deficiencies that parallel those identified in the EXAMS alert. Specifically, GWFS Equities failed to file approximately 130 SARs related to multiple attempts by bad actors to access the retirement accounts of individual plan participants, and of the 300 SARs that it did file regarding these incidents, the firm did not include the five essential components of who, what, when, where, and why. As a result, GWFS Equities had to take corrective measures, including implementing new SAR-drafting procedures and hiring an outside AML consultant to review and recommend improvements to its SAR processes. 

How Guidehouse Can Help

Broker-dealers play a key role in protecting the financial system, and the EXAMS alert serves as a reminder to broker-dealers to take their AML responsibilities seriously. Broker-dealers must implement risk-based AML programs and should continuously review and enhance their policies, procedures, and internal controls. Guidehouse is well-positioned to assist broker-dealers in their AML compliance efforts. Specifically,  Guidehouse can deploy qualified resources to provide AML services to broker-dealers, including:

  1. AML and sanctions independent testing and control reviews.
  2. AML and sanctions risk assessments, including methodologies, execution, risk appetite, and risk-acceptance procedures.
  3. AML and sanctions remediation services, including project management, policies and procedures, and regulatory responses.
  4. Staff augmentation, including transaction monitoring, reporting, and customer due diligence.
  5. AML and sanctions systems implementation.
  6. AML and sanctions model validation.
  7. AML and sanctions training for board of directors and senior management.
Special thanks to contributing author Max Molinari.

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