FRB: Testimony, Biern -- Anti-money-laundering efforts and related proposed legislation -- June 11, 1998 The Federal Reserve Board eagle logo links to home page

Testimony of Herbert A. Biern
Associate Director,
Division of Banking Supervision and Regulation

Anti-money-laundering efforts and related proposed legislation
Before the Committee on Banking and Financial Services, U.S. House of Representatives
June 11, 1998

Mr. Chairman, I am pleased to appear before the Committee on Banking and Financial Services to discuss the Federal Reserve's role in the government's anti-money laundering efforts and our interagency efforts to develop and issue effective "Know Your Customer" rules for the banking industry. As you requested, I will also describe in general terms the Federal Reserve's participation in Operation Casablanca and the issuance of enforcement orders against the foreign banking organizations with U.S. offices identified in the operation. Finally, I will provide some comments on proposed anti-money laundering legislation that you and the members of the Committee are considering.

First, I want to emphasize that the Federal Reserve places a high priority on participating in the government's programs designed to attack the laundering of proceeds of illegal activities through our nation's financial institutions. As a result, over the past several years Federal Reserve staff has engaged extensively in anti-money laundering endeavors on its own and in coordination with U.S. and international bank supervisory agencies and law enforcement authorities.

As bank supervisors, the Federal Reserve believes that it is necessary to take reasonable and prudent steps to assure that banking organizations do not knowingly engage in money laundering. For this reason, and to support our law enforcement agencies in their efforts to combat money laundering, the Federal Reserve's efforts to attack the money laundering problem continue to be one of our highest bank supervisory priorities. As I will describe in more detail, the Federal Reserve has played, and will continue to play, a prominent role in the federal .government's program to reduce and hopefully eliminate money laundering activities through U.S. financial institutions.

Federal Reserve Role
Banking organizations and their employees are the first and strongest line of defense against financial crimes and, in particular, money laundering. It is for this reason that the Federal Reserve emphasizes the importance of financial institutions putting in place controls to protect themselves and their customers from illicit activities. A banking organization's best protection against criminal activities is its own policies and procedures designed to identify and understand with whom it is conducting business and having the capability to identify and then reject potentially illegal or damaging transactions. For this reason, the Federal Reserve and the other regulators have implemented various directives for banking organizations to establish internal controls and procedures designed to detect unusual or suspicious transactions that, if unchecked, could lead to criminal misconduct, including money laundering.

To understand and properly evaluate the effectiveness of a banking organization's controls and procedures, Federal Reserve staff has developed comprehensive examination procedures and manuals. In November 1997, the Federal Reserve issued its newly revised risk-focused Bank Secrecy Act examination procedures. These enhanced examination procedures specifically address anti-money laundering compliance. For example, the examination procedures direct examiners to review written policies of an institution to assess whether senior management has included anti-money laundering procedures in all of the institution's operational areas, including retail operations, credit, private banking, and trust. Examiners are also directed to review existing "Know Your Customer" policies as a preventive measure and as a means to detect and report suspicious money laundering-related activities. In addition, specific examination procedures direct the examiner to determine the effectiveness of systems used by the institution to identify unusual or suspicious activities with regard to cash transactions, exemptions, the sale of monetary instruments and funds transfers. Examiners are also directed to review audit testing procedures to determine if audits are being used to detect, deter and report money laundering activities. Training programs for relevant bank staff in the areas of Bank Secrecy Act compliance and anti-money laundering controls are also evaluated.

Federal Reserve examiners are provided with comprehensive training to assist them in identifying appropriate bank policies and procedures. We also provide training to our examiners on the latest trends in money laundering, as well as techniques for identifying suspicious or unusual transactions. Examiners evaluate the viability of a bank's anti-money laundering policies and procedures designed to enable the bank to, among other things, detect and report unusual or suspicious transactions. However, even with appropriate training, it is still difficult for even the most experienced examiners to detect sophisticated money laundering schemes during the course of an examination. In this regard, I must emphasize that we do not expect our examiners to act as criminal investigators. As a federal bank supervisory agency, we view the Federal Reserve's role as auxiliary to the legitimate law enforcement duties of criminal justice agencies. Our examiners do not, nor should they, possess the necessary tools required to fully investigate and prosecute criminal conduct. If money laundering transactions are identified or strongly suspected during the course of an examination, we immediately notify our law enforcement colleagues.

Having said this, however, in recent years the Federal Reserve has determined that in some instances it is necessary to go beyond the scope of an ordinary bank examination to determine if violations of law have occurred. For this reason, in 1993 the Special Investigations Section was created in the Board's bank supervision division. This unit's function, in part, continues to be that of reviewing information developed during the course of an examination and conducting a specialized inquiry to determine what, if any, laws have been violated through activity conducted at a banking organization. Section staff notifies the appropriate law enforcement agency when apparent criminal violations are detected, and provides support and technical assistance whenever requested. Recent undertakings of this section include uncovering information that led to the conviction for criminal activity related to money laundering and fraud of the Bangkok Metropolitan Bank, a foreign banking organization that subsequently was ordered by the Federal Reserve to cease all operations in the United States, and coordinating the Federal Reserve's recent involvement in Operation Casablanca.

Coordinated Anti-Money Laundering Efforts
In addition to the Federal Reserve's efforts to develop appropriate anti-money laundering-related policies and procedures for the domestic and foreign financial institutions that we supervise and our examination for compliance with those policies and procedures, staff of the Federal Reserve has taken an active role among federal bank supervisors in the law enforcement community's battle to deter money laundering by providing expertise for law enforcement initiatives and training to various government agencies.

The Federal Reserve routinely coordinates with federal law enforcement agencies with regard to potential criminal matters, including anti-money laundering activities. The scope of this coordination ranges from our significant work on the development and implementation of the new interagency Suspicious Activity Reporting system to the referral of illicit activities on a case-by-case basis to law enforcement agencies resulting from examinations of banking organizations.

Training provided by Federal Reserve staff to law enforcement agencies continues to include programs at the U.S. Department of the Treasury's Federal Law Enforcement Training Center and at the FBI Academy, as well as training for the U.S. Secret Service and the U.S. Customs Service. Additionally, Federal Reserve staff has provided training in anti-money laundering procedures to foreign law enforcement officials and central bank supervisory personnel in such countries as Russia, Poland, Hungary, the Czech Republic, and a number of the emerging Baltic states, as well as Brazil, Ecuador, Argentina, China and several other countries in the Middle and Far East.

The Federal Reserve's foreign initiatives also include our staff's active participation in the Financial Action Task Force (FATF), which was established by the G-7 group of countries. Board staff has contributed significantly to the FATF's mission of educating countries around the world in anti-money laundering and fraud prevention efforts. The Federal Reserve also participated in the development of guidance related to serious financial crimes, including money laundering, that was adopted at the recently concluded G-7 ministerial meeting at Birmingham, England.

In addition, the Federal Reserve is a founding member and an active participant in the well regarded interagency Bank Fraud Working Group, which consists of representatives of 13 federal law enforcement and bank and securities supervisory agencies. Among other things, this group, which has been meeting on a monthly basis since the mid-1980s, has coordinated the dissemination of relevant and timely information concerning criminal misconduct involving various banking organizations and their officials.

Know Your Customer
The Federal Reserve believes that the most prudent and effective means by which banking organizations can protect themselves from allowing criminal transactions to be conducted at, or through, their institutions are for the institutions to adopt what has become known as "Know Your Customer" policies and procedures. Illicit activities, such as money laundering, fraud, and other transactions designed to assist criminals in their illegal ventures, pose a serious threat to the integrity and reputation of financial institutions. When transactions at financial institutions involving illicit funds, such as money laundering activities, are revealed, such transactions invariably damage the reputation of the institution involved. While it is practically impossible to identify every transaction at a financial institution that is potentially illegal or is being conducted to assist criminals in the movement of illegally derived funds, it is fundamental for safe and sound operations that financial institutions take reasonable measures to identify adequately who they conduct business with, understand the legitimate transactions to be conducted by those customers and, consequently, identify those transactions conducted by their customers that are unusual or suspicious in nature.

In February 1996, Governor Kelley directed Federal Reserve staff to begin the development of a "Know Your Customer" regulation. The first step in this process was an extensive Federal Reserve effort in 1996 and 1997 to gain a comprehensive understanding of the current "Know Your Customer" policies and procedures of banking organizations operating in the United States and abroad, including the private banking activities of large domestic and foreign banking organizations. Among the actions taken by Federal Reserve staff during this time period were the examinations of several private banking operations in order to determine, among other things, how they have implemented their own "Know Your Customer" policies and procedures. As a result of the year-long private banking review, the Federal Reserve developed and issued a "sound practices" paper on private banking in July 1997. Information gathered from the private banking examinations provided staff with some basic information that was necessary before draft regulations covering banking organizations' relationships with their customers could be prepared.

In the late summer of 1997, the staff of the Federal Reserve prepared a preliminary draft regulation, and then began discussions with the other federal bank regulators in an effort to design a coordinated regulation that would address the "Know Your Customer" activities of all federally supervised banks, thrifts, and credit unions. Representatives of the five federal bank supervisory agencies, along with a representative from Treasury's Financial Crimes Enforcement Network (FinCEN), have been meeting over the past year. Hopefully, we are nearing the end of what has been a complex process. Barring any unforseen complications, we expect that the regulators should be able to issue coordinated notices of proposed rulemaking for "Know Your Customer" regulations that would be applicable to bank as well as non-bank financial institutions within the next few months.

The objective of the "Know Your Customer" regulation will be quite simple. The regulation is designed to protect the reputation of the bank, facilitate the bank's compliance with all applicable statutes and regulations and with safe and sound banking practices, and protect the bank from becoming a vehicle for, or a victim of, illegal activities perpetrated by its customers. One of the benefits of developing and implementing a "Know Your Customer" program is that having an effective program should enhance the relationship between the bank and its legitimate customers.

As the regulators' staff now envision the requirements of the regulation, banking organizations would be required to develop a "Know Your Customer" program that would allow them to identify their customers at the inception of the customer relationship, and understand the source of funds and the normal and expected transactions of their customers. The program should also be designed to allow banking organizations to monitor the transactions of their customers to ensure that they are consistent with their expected transactions, and identify and report, as necessary, those transactions that are unusual or suspicious.

The requirements of the "Know Your Customer" program are expected to be set out in general terms, reflecting the view that a "Know Your Customer" program that is appropriate for one institution may not be appropriate for another. Under the proposed regulation, we would expect each banking organization to design a program that is appropriate to that organization, given its size and complexity, the nature and extent of its activities, its customer base and the levels of risk associated with its various customers and their transactions. The Federal Reserve has long advocated this approach as opposed to a detailed regulation that imposes the same list of requirements on every organization regardless of its specific circumstances and the scope of its business activities.

Operation Casablanca
As the members of the committee are aware, Operation Casablanca was recently made public with the announcement of criminal indictments that included charges of money laundering being brought against numerous bankers, as well as three Mexican banks--two of which operate offices in the United States. As I am sure the committee will understand, I cannot provide specific operational information about Operation Casablanca because the law enforcement agencies responsible for the operation are still working on various aspects of the case. Similarly, confidentiality requirements preclude me from discussing supervisory information about the banking organizations that allegedly may have been involved in improper activities identified during Operation Casablanca. Within these parameters, I would like to describe briefly the Federal Reserve's involvement in the operation.

The Federal Reserve was first made aware of Operation Casablanca in late 1995 when staff was approached by Special Agents of the U.S. Customs Service, the lead agency for Operation Casablanca. The agents requested technical assistance with regard to certain banking aspects of an undercover money laundering sting operation. From that time on, Federal Reserve staff has provided, and continues to provide, assistance to the U.S. Customs Service and the Department of Justice as they complete the investigation and as they now prepare for the various prosecutions resulting from the recently announced indictments. Some of the assistance that we provided included verification as to the existence of banking organizations and the geographic location of their operations, explanations of procedures for the movement of currency between banking organizations and within the Federal Reserve System, training on check clearing and funds transfer procedures, describing the various procedures banks follow in complying with regulatory reporting requirements such as the filing of Suspicious Activity Reports and Currency Transaction Reports, and providing assistance in the post arrest interviews of the bankers who were arrested in the United States.

On May 18th--when the Departments of Justice and Treasury jointly announced the indictments of several banks and bankers resulting from Operation Casablanca--the Board issued enforcement actions, in this case temporary cease and desist orders, against four Mexican banks and one Spanish bank with a Mexican bank subsidiary. Two days later, when several Venezuelan bankers and alleged money launderers were arrested, the Board took a similar enforcement action against a Venezuelan bank with U.S. operations. In total, the Board issued six temporary cease and desist orders resulting from Operation Casablanca.

Specifically, the Board ordered each of the financial institutions to provide a detailed description of the anti-money laundering policies and procedures that it had in place, as well as a detailed description of its understandings regarding the deficiencies in such policies and procedures that could have given rise to the apparent illegal actions taken by its employees. Additionally, the Board ordered each institution to submit an acceptable plan detailing the steps that have been and will be implemented to ensure that conduct, such as that which has already occurred, is not occurring and will not occur in the future. In conjunction with the responses expected from the six banking organizations, the Federal Reserve has begun in-depth targeted reviews of their anti-money laundering policies and procedures, and staff continues to monitor each of the implicated banks with U.S. operations.

Proposed Legislation
Finally, you have asked us to comment on legislation you proposed, entitled the "Money Laundering Deterrence Act of 1998," as well as legislation proposed by Congresswoman Velazquez, entitled the "Money Laundering and Financial Crimes Strategy Act of 1998." While the Board has not had an opportunity to review either proposal, as a general proposition the Federal Reserve has always supported constructive efforts to better and more efficiently attack money laundering activities. From staff's review of the proposals, it appears that the legislation, among other things, would increase the tools available to law enforcement authorities to combat money laundering on the one hand, and establish a coordinated government-wide effort against money laundering on the other.

With specific regard to the "Money Laundering Deterrence Act of 1998," staff is particularly pleased with the clarification of some issues related to the disclosure of Suspicious Activity Reports. The filing of Suspicious Activity Reports by banking organizations is a vital tool for the government's anti-money laundering efforts, and your legislative proposal enhances the organizations' ability to communicate with law enforcement and bank supervisors in a timely and effective manner without the threat of inappropriate legal challenges. We also appreciate the importance that the proposed legislation places on "Know Your Customer" regulations as an integral component of an effective government anti-money laundering program.

With respect to the "Money Laundering and Financial Crimes Strategy Act of 1998," we believe that coordination already exists among and between the various governmental bodies that participate in anti-money laundering efforts. If the Congress were to determine that .the development of a national strategy in this area is appropriate, then we would welcome the opportunity to participate in such an initiative.

Over the last several years, the Federal Reserve has undertaken extensive efforts to develop programs, procedures and systems to better detect and deter illegal money laundering activities at individual banking organizations as well as address systemic issues related to financial institutions' compliance with applicable anti-money laundering laws and regulations, including the Bank Secrecy Act. The Federal Reserve has also provided training and technical assistance to law enforcement agencies participating in the government's anti-money laundering efforts and to international banking and law enforcement authorities.

These actions underscore the Federal Reserve's significant commitment to the bank regulatory community's anti-money laundering mission. The Federal Reserve has a vital interest in protecting the banking system from criminal elements. Consequently, we will continue our cooperative efforts with other bank supervisors and the law enforcement community to develop and implement effective anti-money laundering programs addressing the ever changing strategies of criminals who attempt to launder their illicit funds through banking organizations here and abroad.

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1998 Testimony