4/30/08

Sue Burt Senior Attorney and Editor, ComplianceHeadquarters.com, Wolters Kluwer Financial Services

Introduction

In recognition of the progress the industry has made in anti-money laundering compliance, the Financial Crimes Enforcement Network (FinCEN) has issued a notice of proposed rulemaking that would streamline the currency transaction report (CTR) exemption process. Comments on this proposal are due on or before June 23, 2008. As financial institutions continue to struggle with compliance burdens and economic hard times, this type of regulatory relief is more than welcome.

This article will discuss the exemption process and the changes proposed.

CTR Exemption Overview

The backbone of Bank Secrecy Act (BSA) compliance involves monitoring currency transactions and filing a CTR any time more than ten thousand dollars of cash is deposited, withdrawn, or exchanged through a financial institution. For certain depositors–those who legitimately deal in large quantities of cash on a regular basis–the law contains exemption rules. These exemptions from filing help prevent the system from being inundated with reports that carry little risk of criminal activity and thus little investigative value.

Effective in 1998, the exemption process went through a fairly extensive revision. This revision consisted of two phases and is codified at 31 CFR 103.22(d). Phase I created a streamlined exemption procedure that allowed institutions to automatically eliminate CTR filings involving:

• Other banks and credit unions operating in the US;
• Government agencies;
• Companies listed on the major national stock exchanges; and
• Subsidiaries of these publicly traded companies.

The procedure for exempting these entities is fairly simple.

From the government’s perspective, Phase I did not sufficiently reduce the number of CTR filings. As a result, FinCEN issued Phase II of its exemption reform efforts. The Phase II rules were aimed at the exemption of non-public companies, especially smaller businesses. Two new types of exempt persons were established under the Phase II rules and include “non-listed businesses” and “payroll customers.” Phase II of the reform plan replaced the unilateral and special exemption processes and applies to non-listed businesses and payroll customers.

Non-listed businesses. Subject to certain exceptions, a “non-listed business” is one that is not listed on any major public stock exchange, such as the New York or American Stock exchange, and includes most retail and wholesale businesses. It also includes very small businesses, such as sole proprietors.

According to the current law, in order for non-listed businesses to be exempt, certain conditions must be met. The depositor must:

• Have a transaction account with the institution that has been open for at least 12 months;
• Frequently engage in currency transactions of over $10,000;
• Be incorporated in a state or registered to do business in a state of the United States; and
• Not be an ineligible business.

If these conditions are met, then the non-listed entity may be exempted from CTR filings.

Payroll customers. Another category of exempt persons addressed under the current law is “payroll customers.” These are customers who engage in frequent cash withdrawals for payroll purposes.

 In order to be exemptible as a payroll customer, certain conditions must be met. The depositor must:

• Have a transaction account with the institution that has been open for at least 12 months;
• Frequently withdraw more than $10,000 in cash for payroll purposes in order to pay its employees in the US; and
• Be incorporated or organized under the laws of the United States, or a state, or be registered and eligible to do business in the United States.

Currently, an institution exempting a customer must file a FinCEN Form 110, Designation of Exempt Person, within 30 days after the first transaction which the bank wishes to exempt. For Phase I customers, this filing need only be done once but the exemption must be reviewed annually. For Phase II customers, you must conduct an annual review of the customer and renew the exemption by re-filing Form 110 every two years.

Proposed CTR Exemption Amendments

FinCEN has proposed changes to the CTR exemption process in an effort to increase the effectiveness and efficiency of its BSA enforcement efforts. Many of the changes stem from a report issued by the Government Accountability Office entitled Bank Secrecy Act:  Increased Use of Exemption Provisions Could Reduce Currency Transaction Reporting While Maintaining Usefulness to Law Enforcement Efforts. In a nutshell, the exemption proposal makes three main recommendations:

• Eliminate the 12-month time period for exempting Phase II customers and replacing this with a risk-based approach;
• Eliminate the filing of exemption forms and annual review of data for banks, federal, state, and local government agencies and entities exercising federal, state, or local governmental authority; and
• Eliminate the requirement to renew Phase II exemptions every two years.

The following will discuss these three proposals in greater depth.

Length of Time to Consider Phase II Entities for Exemption

In its proposal, FinCEN proposes to remove, or at least reduce, the prescribed amount of time before an institution can consider a non-listed business or a payroll customer for exemption. Because of the time-consuming process currently in place, many institutions bypass the exemption and simply file CTRs on entities that otherwise qualify for an exemption. One alternative proposed by FinCEN is that rather than wait for a 12-month account history, institutions should make a risk-based determination as to when it has a sufficient history with a particular customer that an exemption is warranted. A second alternative is to keep the account history requirement but reduce the history time frame from 12 months to two months.
 
As an aside, FinCEN also proposes a separate risk assessment paragraph that would require institutions to conduct a risk assessment of the customer’s transactional activity before granting an exemption to a non-listed business or payroll customer. This separate risk assessment requirement is in addition to the risk assessment approach mentioned for determining a sufficient history to grant an exemption. Under this risk-based approach, the amount of time an account has been opened would be one factor to consider in forming a reasonable belief that the customer qualifies for an exemption. Other factors to consider in your risk assessment include whether you have had a past relationship with the customer, characteristics of the customer’s business model that may be pertinent, the type of business the customer is engaged in, and where the business operates.

Elimination of Filing for Phase I Customers

A second amendment proposed by FinCEN is to remove the requirement that institutions file an initial designation of exempt persons using FinCEN Form 110 for eligible Phase I customers that are depository institutions, federal, state or local governments, or entities exercising governmental authority. The reason for this proposal is simply that CTRs filed on these types of entities have little value for law enforcement. Furthermore, if any of these types of entities were to engage in suspicious unlawful activity, the institution would still be required to file a suspicious activity report (SAR). Keep in mind, however, that even though the filing requirement may be eliminated, you still would be required to take steps to assure yourself that the Phase I customer is an exempt person. You would also need to document the basis for your conclusions so as to protect yourself from fraud due to misidentification of the customer’s status.

In addition to the elimination of filing for Phase I customers, FinCEN also proposes removing the requirement to conduct an annual review. The reason for this is that Phase I entities are unlikely to change the characteristics that made them eligible for exemption; whereas a public company is more likely to reorganize or enter a new line of business. Keep in mind you would still be required to review and verify exempt status for Phase II customers annually.

Elimination of Biennial Filing

Another CTR exemption proposal made by FinCEN is to eliminate the requirement that institutions biennially file a designation of exempt person for non-listed and payroll customers. Relying on the GAO report, FinCEN notes that filings every two years didn’t provide any real additional benefit and eliminating this requirement might help encourage institutions that haven’t previously exempted Phase II customers, to do so. If this requirement is removed, institutions would no longer have to certify that their system of monitoring the currency transactions of an exempt person for suspicious activity had been applied. Of course, this in no way is intended to modify the SAR filing requirements for those Phase II customers. Also, you will still need to file change in control information with FinCEN as necessary.

Revocation Notice

One final change noted in the exemption proposal is to require institutions to report to FinCEN a decision to no longer treat a previously exempted customer, and otherwise exemptible entity, as exempt. Currently this type of notification is voluntary. Under the proposal, a notice of revocation of exemption would need to be filed with FinCEN within 30 days after the first CTR filed on the previously exempted person.

Conclusion

Again, the comment period for the CTR exemption proposal ends on or before June 23, 2008. FinCEN is making an effort to encourage the use of CTR exemptions so as to avoid clogging the system with CTRs that provide little enforcement benefit. Diluting the system with CTRs that don’t require law enforcement attention hurts everyone except perhaps those bent on criminal activity. Review the CTR exemption proposal and consider whether your organization could be taking greater advantage of the exemption process.

Our Red Flag Resource Center can assist you in complying with the red flag regulatory requirements.