Testimony of Richard Spillenkothen
Director, Division of Banking Supervision and Regulation
Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate
January 29, 2002
Mr. Chairman, I am pleased to appear before the Committee on Banking, Housing, and Urban Affairs to discuss the Federal Reserve's work on implementing the USA Patriot Act and our efforts to help law enforcement track terrorist financing activities. The U.S. government's response to the terrorist attacks on September 11th has necessitated unprecedented cooperation among federal bank supervisors, the private sector, law enforcement agencies and the international financial community. Over the past several months, the Federal Reserve has played an important role in many joint activities with bank supervisory and law enforcement authorities and the banking community here in the United States and abroad.
As you requested, today I will describe many of the Federal Reserve's efforts - some of which you may appreciate can only be discussed in general terms in order to avoid compromising on-going law enforcement inquiries. At the outset, I will discuss our current robust anti-money laundering program and the ways that we're enhancing it to address terrorist financing. I will then describe how the Federal Reserve is actively involved in the implementation of the Patriot Act; how the Federal Reserve staff has been participating in the work of numerous international organizations; and how we have been providing support and technical assistance to law enforcement.
As a preliminary matter, I would like to highlight an important fact about terrorist financing activities that is presenting a major challenge to the Federal Reserve, the other bank supervisory agencies, the banking community, and law enforcement. Terrorist financing activities are unlike traditional money laundering in a very significant respect. Money used to finance terrorism does not always originate from criminal sources. Rather, it may be money derived from legitimate sources that is then used to support crimes. Developing programs that will help identify such funds before they can be used for their horrific purposes is a daunting task, but we are trying to meet this responsibility along with our colleagues at the U.S. Departments of Treasury and Justice, the Securities and Exchange Commission and other U.S. and international regulatory and law enforcement agencies.
Fortunately, we have a strong foundation upon which to build. Many of the provisions of the Patriot Act are amendments to the Bank Secrecy Act (BSA), the core of U.S. anti-money laundering efforts. Therefore, I would like to first describe our existing BSA compliance examination program, then explain how we are revising it to address terrorist funding activities and the new provisions of the Patriot Act.
The Federal Reserve's Anti-Money Laundering Program
Throughout the Federal Reserve System, the Reserve Banks have designated senior experienced examiners as BSA/Anti-Money Laundering Contacts. During every Federal Reserve examination of a state member bank or U.S. branch or agency of a foreign bank, specially trained examiners review the institution's compliance with the BSA. Examiners also evaluate compliance with regulations that require banks to establish internal control and training procedures and to perform independent testing to assure and monitor compliance with the BSA. Prior to commencing an examination of a state member bank or U.S. branch or agency of a foreign bank, examiners also make use of the BSA database of Currency Transaction Reports (CTRs) and Suspicious Activity Reports (SARs) filed by the particular banking organization in order to check, among other things, whether the bank, branch or agency has adequate systems in place to identify and report currency transactions and suspicious activities in accordance with Treasury's and the Board's rules.
When supervised institutions fail to have the appropriate internal controls and procedures for compliance with the BSA as well as for anti-money laundering purposes, the Board may issue formal enforcement actions and assess civil penalties to correct the systemic deficiencies. These actions are public and are available on the Board's web site. In cases of significant BSA violations, relevant examination materials are referred to Treasury for action under its authority to assess fines for BSA violations. When potential money laundering (or other criminal activity) is identified through an examination, or self-disclosure or from information received from law enforcement, a targeted examination may be conducted, and all relevant information is referred to the appropriate law enforcement agency.
Federal Reserve examiners are provided with comprehensive training on the latest trends in money laundering. However, even with appropriate training, it is still difficult for the most experienced examiners to detect sophisticated money laundering schemes during the course of an examination. In this regard, I must emphasize that our examiners are not criminal investigators. It is the examiner's primary responsibility to evaluate the effectiveness of the institution's own policies and procedures to identify and manage the risks associated with money laundering. As a federal bank supervisory agency, we view the Federal Reserve's role as complementary to the law enforcement duties of criminal justice agencies.
Working with Treasury on the Implementation of the Patriot Act
As you are aware, the primary responsibility for these regulations rests with Treasury; however, at the request of Treasury staff and consistent with statutory requirements for consultation, the Federal Reserve has been actively assisting that agency. Treasury has established twenty working groups for the different regulatory projects required by the Patriot Act, and Federal Reserve staff is involved in fifteen of these groups.
Along with Treasury, Federal Reserve staff started working on those provisions of the Patriot Act that have effective dates in the immediate future. Treasury's recently proposed rules on the prohibition of correspondent accounts with shell banks; the recordkeeping requirements on foreign bank ownership and designation of agents for service of legal process for correspondent accounts; and the broker-dealer suspicious activity reporting requirements all reflect consultation with the Federal Reserve.
Further, Treasury is expected to issue more proposed rules shortly, one setting forth minimum standards for financial institutions to verify the identification of their customers and another requiring financial institutions to conduct due diligence to identify suspicious activities involving correspondent and private banking accounts. Board staff is providing material assistance to Treasury in the drafting of both of these regulations.
Patriot Act Examination Enhancements
At the Board, we have established a Patriot Act Working Group comprised of senior, experienced Bank Secrecy Act/Anti-Money Laundering examiners from throughout the Federal Reserve. This Working Group, which is charged with overseeing the System's implementation of the new law, is drafting new examination procedures and developing a new training curriculum for examiners who conduct Bank Secrecy Act and anti-money laundering examinations.
We have also increased the staff of the Board's bank supervision division to include several senior examiners from our Reserve Banks to draw upon their field experiences. These new Special Examiners will lead the Working Group; coordinate the System-wide adoption and consistent application of the new examination procedures and training program; and consult with the other federal supervisors on common issues.
Cooperation with the Private Sector
While many of our banks have robust compliance procedures in place, clearly, the recent events underscore the absolute need for banking organizations to conduct effective enhanced due diligence. We are working with law enforcement and the industry to see whether there are any specific indicators of terrorist-related money laundering that may be distinguishable from money laundering involving corruption or drugs. This effort will be crucial not only for law enforcement to identify suspects but also for supervisors to determine if there is a way in the future for potential suspicious activity related to terrorism to be detected proactively.
Another example of industry cooperation is our work with the New York Clearing House (NYCH), which is comprised of representatives from some of the leading U.S. and international financial institutions. On October 11, 2001, senior executives from the NYCH member institutions, and senior level representatives from the Federal Reserve, law enforcement, Treasury and Justice and other federal bank supervisors met for the first time to plan how to work together to identify and intercept the flow of funds to and from terrorists and their organizations.
Under the auspices of the NYCH and in cooperation with the Federal Reserve and the other bank regulators, working groups have been established to: review account opening and monitoring procedures; develop a database for financial institutions to share information about suspicious activity with law enforcement and each other; determine patterns of terrorism financing; broaden international cooperation on information sharing; and ensure that a useful flow of information between law enforcement and financial institutions continues. Federal Reserve staff participates in all of these groups.
Since the issuance of our supervisory letter in November to Federal Reserve-supervised financial institutions, Board and Reserve Bank staffs have reached out to the banking industry, fielding numerous written and telephone inquiries and participating in many seminars, conferences and meetings with banking organizations and their representatives. Federal Reserve staff welcomes the opportunity to assist the industry in responding to new challenges, and we believe that a strong relationship with our supervised organizations can only further our collective goals.
Banks and other financial institutions have raised many questions about how they ensure that they are not doing business with shell banks and ensure that they have all necessary ownership information about the foreign banks with whom they are doing business. Working with Treasury, the NYCH, and the Federal Reserve and other bank regulatory agency staff, banks have begun using the "certification process" provided for by Treasury's regulations and have been searching for correspondent accounts with shell banks through deposit accounts as well as other business lines. Through our contacts with banking organizations examined by the Reserve Banks we have learned that several correspondent accounts with shell banks have been closed by U.S. banks.
Financial institutions supervised by the Federal Reserve have also raised questions about the application of the requirement to determine ownership of foreign correspondent banks. Treasury has specifically requested comments on this provision in connection with its proposed regulations. In the meantime, we believe that banks are making their best efforts to comply. We are encouraged that banking organizations have taken steps to prepare for compliance with the Patriot Act, and we have seen an increase in the number of banks that have improved existing systems or implemented new or more sophisticated systems to monitor funds transfers and identify suspicious activity.
With respect to multilateral organizations, Board staff participates in the Financial Action Task Force (FATF). The FATF, established in 1989 at the G-7 Economic Summit, develops and promotes policies to combat money laundering. The FATF has working groups that are reviewing some of the same issues addressed by the Patriot Act such as minimum standards for customer identification and due diligence requirements for correspondent banking as well as other practices susceptible to money laundering.
The FATF held an extraordinary plenary session in October in response to the terrorist attacks and adopted eight special recommendations regarding terrorist financing. To implement the new recommendations, FATF members agreed to draft guidance for financial institutions on the techniques and mechanisms used in the financing of terrorism and to provide technical assistance to non-members to assist them in complying with the special recommendations. Board staff is involved in all of these projects.
Another important international initiative to which the Federal Reserve contributes is the Basel Committee on Banking Supervision. The Basel Committee is comprised of representatives of central banks and supervisory agencies from a dozen countries. The Committee does not possess any supervisory authority but formulates broad supervisory standards, guidelines and recommendations for best practices.
On October 4th, the Basel Committee issued minimum standards for customer due diligence for banks. In issuing these standards, the Chairman of the Committee, William J. McDonough, President of the New York Reserve Bank, reiterated that due diligence is an essential element of banks' risk management systems, the importance of which has been underscored by the recent terrorist attacks.
Another organization working on anti-terrorist financing initiatives is the Wolfsberg Group. It is comprised of representatives from several large multi-national financial institutions. This Group held a meeting on terrorism financing in early January and invited government and banking experts to discuss these issues. Board staff attended and gave a presentation on U.S. initiatives taken since September 11th. The Group intends to issue a paper identifying "best practices" on the prevention of terrorism financing and hopes that these practices will be adopted by the international banking community.
The Board also participates in the G-7 group, composed of the finance ministers and central bank governors of large industrial countries, and the G-20 group, composed of ministers and governors of emerging-market countries. Following the G-7 meeting in Washington on October 6, 2001, the G-7 ministers and governors issued a statement that highlighted the commitment of its members "to vigorously track down and intercept the assets of terrorists and to pursue the individuals and countries suspected of financing terrorists." On November 17, 2001, finance ministers and central bank governors of the G-20 announced a comprehensive action plan of multilateral cooperation to deny terrorists access to their financial systems. The plan commits members of the G-20 to take a number of concrete steps in cooperation with other international bodies to combat terrorist financing and money laundering.
Assistance to Law Enforcement
Shortly after September 11th, the FBI sought our assistance in circulating a list of suspected terrorists to banks. The Bureau wanted the banks to check their account and transaction records against this list and report any positive responses to law enforcement as quickly as possible. Within twenty-four hours of that request, the Federal Reserve and the other federal banking supervisors disseminated the list to virtually every banking organization in the country. The Federal Reserve distributed this list by issuing a supervisory letter to all of its banking organizations.
Soon thereafter, Treasury's FinCEN set up a telephone hotline so that banks and others could report suspicious activities related to terrorism through FinCEN to the FBI, thereby enabling law enforcement to receive information on almost a real time basis. We advised the financial institutions supervised by the Federal Reserve about this new procedure as soon as it was in place by issuing another supervisory letter.
From the middle of September through October, the proliferation of various requests continued as banks received increasingly longer lists from a variety of law enforcement sources, both domestically and abroad. To alleviate the burden of searching for names on these multiple lists, many of which were duplicative, the FBI and other law enforcement agencies prepared a unified "Control List" to supersede all other lists.
To ensure that the broadest number of financial institutions received this Control List, it was agreed that electronic communication would be the most efficient and expeditious method of distribution. The New York Reserve Bank, working with the U.S. Attorney for the Southern District of New York, devised a dedicated e-mail account that allows banks to receive one Control List from law enforcement. Banks respond with positive information back to this same e-mail account, and the information is then forwarded promptly to law enforcement for further action such as an issuance of a subpoena. The Federal Reserve and the other federal bank supervisors issued a Joint Agency Request explaining this system to almost 20,000 financial institutions. Cooperation from the banking industry has been outstanding despite the time consuming effort that is needed to run name checks on many similar names with few identifiers. This system continues to be active, and, to date, there have been over two hundred responses forwarded to law enforcement.
The Federal Reserve provided the Control List to the Basel Committee for circulation among its member countries. In addition, the Federal Reserve sent the Control List to over a dozen other central banks around the world.
The Control List is different, of course, from Treasury's Office of Foreign Assets Control (OFAC) list. OFAC disseminates its own list for which many banks have automated filters to block transactions and assets or to deny transactions altogether. Most banks are notified of additions and modifications to the OFAC list through Fedwire, the Federal Reserve's large value electronic payments system. The OFAC list has been amended numerous times since September 11th, and U.S. banks have diligently complied with their responsibilities to block and freeze accounts.
Finally, I can report that starting on September 17, 2001 the New York Reserve Bank, at the request of law enforcement and pursuant to subpoenas, began searching the records of Fedwire for information related to the terrorist acts. Search results have been provided to various law enforcement agencies, which have reported to us that the information we provided has been useful in their on-going investigations.
In addition, multi-agency teams led by various U.S. government agencies have been deployed to foreign countries to analyze bank and other financial records. On several of these occasions, senior Reserve Bank examiners have traveled and worked with the teams. The feedback we received is that our expertise was of great assistance and that the foreign jurisdictions welcomed the presence of a central bank examiner on the investigative teams. Based on information developed by the team members, OFAC included new entities and individuals on its lists.
In the wake of the terrorist attacks, the FBI formed the Financial Review Group (FRG), a multi-agency law enforcement task force to trace transactions and assets of terrorists and their supporters here and abroad. Recognizing the particular expertise that we have in financial investigations and our facility with bank records, representatives from the group of specialized examiners that I referred to previously -- the Federal Reserve's Special Investigations Section -- were requested to participate. Staff from this group regularly participates in the FRG's efforts.
Over the past several months, Federal Reserve staff has assisted in the evaluation of financial data collected by the FRG and has provided other valuable services to the law enforcement officials participating in the FRG. For example, a need very quickly developed for information on specific foreign banking organizations. Law enforcement sought details such as ownership, organizational structure, nonbank subsidiaries and geographic location of operations. Special Investigations Section staff was able to obtain this information very promptly. Additionally, FRG staff needed information relating to funds transfer systems; wire transfer practices, particularly in the Middle East; non-traditional funds transfer methods; and general banking practices, such as account opening procedures. Federal Reserve staff helped to answer these questions.
The Federal Reserve has also provided assistance and technical support to OFAC's Foreign Terrorist Asset Tracking Center. This OFAC group gathers information relating to terrorist groups' methods of fundraising and funds movement.
All of the actions I described underscore the Federal Reserve's significant commitment to the bank regulatory community's anti-money laundering and anti-terrorism mission. We will continue our cooperative efforts with Congress, the banking industry, the other bank and securities supervisors, and international communities to develop and implement effective programs addressing the ever-changing strategies of terrorists and other criminals who attempt to launder funds through banking organizations here and abroad. The Federal Reserve will also continue to lend our expertise to the U.S. law enforcement community anywhere in the world when it seeks to track or intercept terrorist funds.
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Last update: January 29, 2002, 10:00 AM