Detecting and Preventing Money Laundering in Brokerage: Strategies for Compliance
In the world of finance, broker-dealers are under increasing scrutiny for potential money laundering activities. This heightened focus is due to the vast number of financial operations and international actors involved in the trading industry.
The Financial Industry Regulatory Authority (FINRA), the main regulatory body in the US, has outlined five categories of red flags that companies should look out for. These categories include Money Movements, Securities Trading, Deposits and Securities, Insurance Products, and Customer Due Diligence (CDD) and Interactions with Customers.
Red flags in the Money Movements category include customers breaking funds transfers into smaller transactions to avoid raising suspicion, or using wire transfers for no apparent reason, especially to high-risk countries. In the Securities Trading category, red flags include placing and entering multiple orders from both sides of the market, engaging in pre-arranged or non-competitive securities trading, or making a large purchase or sale of a security shortly before a significant announcement that affects the price of the security.
Red flags in the Deposits and Securities category include depositing finances and shortly after requesting their withdrawal, depositing or receiving large amounts of low-priced, non-exchange listed securities, or sending shares into multiple seemingly unrelated accounts. In the Insurance Products category, red flags include conducting unusual operations such as canceling an insurance contract and directing funds to a third party, repeatedly opening and closing accounts with one insurance company, or purchasing an insurance product with no concern for the investment objective or performance.
Red flags in the CDD and Interactions with Customers category include a customer refusing to provide certain information, provided information not matching documents, a customer coming from a high-risk country, a customer having no apparent reason for using services from another country, a customer with a history of account rejection or termination in other financial institutions, or a customer being on sanction lists or Politically Exposed Persons (PEP) lists.
Broker-dealers are also required to implement policies and internal controls compatible with the risk profiles of their staff members, customers, and financial activities. FINRA's Rule 3310 requires broker-dealers to implement a written AML compliance program tailored to the specific risks of their business, including customer onboarding and risk ranking processes to detect elevated risk clients effectively.
The search results do not provide a single exhaustive list from FINRA specifically labeled "common red flags," but the following are commonly implied red flags based on FINRA's regulatory focus and enforcement actions: unusual or complex trading patterns such as spoofing and layering, frequent use of unapproved communication channels for client interactions, offshore accounts or transactions lacking clear financial institution relationships, clients reluctant to provide complete or consistent information during onboarding, sudden changes in investment patterns inconsistent with client profile, requests for wire transfers to unrelated third parties or foreign accounts, and lack of transparency about the source of funds or beneficiary.
Broker-dealers should ensure they maintain adequate resources and governance structures to monitor these red flags effectively as part of their AML program. Companies must check whether their customers are featured within any sanction lists, PEP lists, and adverse media, among others.
In the UK, the main AML regulator is the Financial Conduct Authority (FCA). The Money Laundering, Terrorist Financing, and Transfer of Funds (Information on the Payer) Regulations 2017, The Proceeds of Crime Act 2002, Terrorism Act 2000 and 2001, and Counter-Terrorism Act 2008 are regulations in the UK. Companies should implement proper CDD procedures, including collecting the personal data of their customers.
The EU plans to create an institution dedicated to confronting money laundering in the Union. New regulations on AML, which will unify EU AML requirements, including CDD, are planned. The trading industry's close monitoring by AML regulators is not limited to the US and UK. The Financial Crimes Enforcement Network (FinCEN) is a US organization that punishes criminals and criminal networks related to money laundering activities.
In July 2021, the European Commission presented a package with a series of proposals against money laundering in the region. Every broker in the US is required to file suspicious activity reports with FinCEN. The EU countries based their AML regulations on several EU legislative directives-4 AMLD, 5 AMLD, and 6 AMLD.
As the fight against money laundering continues, it is crucial for broker-dealers to stay vigilant and comply with regulatory requirements to maintain the integrity of the financial system.
In the realm of education and self-development, understanding the red flags in the finance industry is essential for financial professionals and investors to avoid potential money laundering activities. For instance, broker-dealers should be aware of unusual trading patterns such as spoofing and layering, frequent use of unapproved communication channels, and offshore accounts lacking clear financial institution relationships, which are commonly implied red flags. By implementing proper know-your-customer (KYC) and anti-money laundering (AML) procedures, individuals can contribute to the wider effort against money laundering in the business world. Furthermore, it's crucial for broker-dealers to cooperate with AML regulatory bodies like FINRA, FCA, and FinCEN in the US, UK, and EU to ensure the integrity of the financial system.
