The business of catering to high net worth individuals who seek confidentiality is booming. Often those customers are nonresidents aliens, moving assets to locations where U.S. banks have established corporations veiled in secrecy laws. Regulators are concerned not only about the growth of this type of business, but they are also concerned about issues such as compensation methods, the pressures to obtain new clients, and the monetary rewards for those salespersons who do produce. All of these elements combine to form an atmosphere conducive to wrong-doing.
For example, one former private banker is about to face ten years in jail for laundering drug money. His former boss, who helped convict him, is the focus of another investigation by the justice Department. And a potential witness in that investigation, convicted recently of money laundering, faces a lifetime in prison. Our system is sending individuals to jail -- not financial institutions.
The Government Accounting Office (GAO) has announced that it is investigating private banking and its ties to money laundering, which could take as long as six months to complete. So, if you are a banker, stand alerted -- not only should your institution have strong Know Your Customer (KYC) policies and procedures -- you personally had better understand and follow them.
What do private bankers really need to know about their customers? The Federal Reserve has yet to issue its long awaited KYC regulations. (We now expect them sometime in 1998.) However, the Fed has been directing many resources at reviewing private banking activities at numerous institutions. These reviews have been conducted to both enhance the Fed's knowledge base and also to assess institutions' ability to recognize and manage the potential legal and reputational risks.
On June 30, 1997, the Fed issued a Supervisory Letter (SR97-19) on private banking activities, which includes a paper prepared by the Federal Reserve Bank of New York entitled "Guidance on Sound Risk Management Practices Governing Private Banking Activities." The paper describes certain essential elements that would be associated with sound private banking activities. The Fed's review will result in a new private banking examination manual which is now in draft. The lessons learned through the targeted review will also be incorporated into the promised Know Your Customer regulations.
The controls the Fed will be emphasizing center on 1. management oversight, 2. policies and procedures, 3. risk management practices and monitoring systems, and 4. segregation of duties, compliance, and audit.
The New York Fed's guidance resulted from a review the regulator undertook of approximately 40 domestic and foreign banking organizations in the Second District. Examiners focused on assessing each institution's ability to recognize and manage the potential reputation and legal risks that may be associated with inadequate knowledge and understanding of its clients' personal and business backgrounds, sources of wealth, and uses of private banking accounts. The review resulted in a sound practices paper that provides guidance to bankers regarding the basic controls necessary to minimize reputation and legal risk and to deter illegal activities such as money laundering. While the paper is not regulation, it is certainly guidance on the types of controls the Fed will be looking for.
Guidance already exists
We are still waiting for any action by the Treasury Department's FinCen regarding KYC guidelines. However, other requirements such as suspicious activity reporting already mandate that institutions know their customer.
We expect that any issuance by Fincen will be in line with the suspicious transaction reporting requirements which stipulate that banks must "know, suspect or have reason to suspect" that a reportable event has occurred. The commentary that accompanied the FinCen final rule on suspicious activity reporting provides a good idea of Treasury's direction. …