Court Ruling Confirms Power of US Federal AML Examination Manual

By Daniel Bethencourt and Valentina Pasquali

The manual U.S. regulators use to assess financial institutions’ compliance with federal anti-money laundering rules has gained new standing thanks to the 9th U.S. Circuit Court of Appeals, which recently ruled that the document all but contains the power of law.

In the past few years, the 442-page manual maintained by the Federal Financial Institutions Examination Council, or FFIEC, an interagency panel consisting of the Federal Deposit Insurance Corp. and other U.S. regulators, became the focal point of a small San Francisco-based lender’s legal challenge against enforcement of the Bank Secrecy Act.

The protracted legal battle that began with California Pacific Bank’s initial challenge against an FDIC enforcement action in August 2013 ended March 12, when the 9th Circuit rejected the lender’s argument that the Bank Secrecy Act is unconstitutionally vague and the FFIEC manual does not aid compliance with the law as it holds neither legal nor regulatory authority.

The 9th Circuit agreed with the FDIC that the manual is actually what clarifies the BSA, and determined that California Pacific must have known this to be the case because it had implemented several of the FFIEC’s suggestions into its written AML policies and procedures and even has copies of the guide “scattered throughout the bank.”

“It is clear that a detailed manual issued by agencies with enforcement authority, such as the FFIEC manual, can put regulated banks on notice of expected conduct,” judges wrote in a 35-page decision. “A BSA officer at the bank bearing the requisite ‘specialized knowledge’ would understand that compliance with the FFIEC manual ensures compliance with the BSA.”

The case marks the first significant legal challenge against federal interpretation and enforcement of the Bank Secrecy Act, and the court’s ruling against California Pacific will confer authority on future AML guidance issued by regulators, according to Jonathan Lopez, a former federal prosecutor.

While the decision does not impose a binding precedent across the United States, other courts will still look and defer to the ruling when deciding similar cases, Lopez said.

“‘May’ is becoming a ‘shall,’” said Lopez, now an attorney at Orrick in Washington, D.C. “That’s the fear of this case—that it’s basically saying, the law is whatever FinCEN [the Financial Crimes Enforcement Network] says it is.”

Even before the 9th Circuit ruling, federal examiners often viewed and enforced the FFIEC manual as regulation, Rick Small, a senior compliance officer at BB&T Bank in North Carolina, told attendees of the ACAMS AML & Financial Crime Conference in Florida last month.

“I see too often in talking to my colleagues that examinations start with the exam manual but then it becomes requirements,” Small said. “I was very vocal until this recent court case in saying that the exam manual is not a regulation.”

Back to the start

In December 2012, during the examination of California Pacific Bank that first prompted the legal challenge, the FDIC found violations of all “four pillars” of an effective AML program as required by regulations: written internal policies and procedures, designation of a qualified compliance officer, adequate training of staff and independent testing.

Richard Chi, then the bank’s chief executive officer, had named his son, Alan, as acting BSA officer the prior year without interviewing other candidates for the role, according to the 9th Circuit ruling.

The bank’s board later confirmed Alan Chi’s appointment despite his dearth of relevant experience and his conflicting duties as the lender’s chief financial officer and internal auditor.

Chi proceeded to rate the AML risk that California Pacific Bank’s had to manage as low, similarly downplayed the risks posed by new accountholders, then failed to file a suspicious activity report on relevant transactions after the lender was subpoenaed for client details during an FBI investigation into espionage and misuse of trade secrets.

When the FBI warned Chi not to disclose the existence of the subpoenas in August 2011—the same month he became head of BSA compliance—he mistakenly believed that filing a SAR would contravene the bureau’s instructions.

Banks rarely appeal against a cease and desist order for fear of damaging their relationship with regulators, and the decision against California Pacific Bank may discourage similarly predicated legal challenges, Dan Stipano, former deputy chief counsel for the Office of the Comptroller of the Currency, said.

“I think the real significance of the decision is that it effectively gives the manual the weight of law,” Stipano, now a partner with Buckley Sandler LLP in Washington, D.C., said. “It’s saying that what’s in the manual is not mere guidance, they are not suggestions, this is something that you have to do—and it puts you on notice on what the requirements are.”

A senior regulator said at the ACAMS conference in Florida that federal agencies would update the examination manual to incorporate FinCEN’s customer due-diligence rule and beneficial-ownership requirements, which take effect May 11.

Topics : Anti-money laundering , Counterterrorist Financing
Source: U.S.: FinCEN , U.S.: Federal Financial Institutions Examination Council , U.S.: FDIC , U.S.: OCC , U.S.: Federal Reserve Board
Document Date: May 4, 2018