7/2/08

Robert G. Rowe, III Senior Regulatory Counsel , Independent Community Bankers of America

The Treasury’s Financial Crimes Enforcement Network (FinCEN) recently proposed to streamline how banks exempt customers from filing currency transaction reports (CTRs). The goal is to simplify Bank Secrecy Act (BSA) reporting by making it easier to file as a way to encourage banks to exempt more customers and reduce the volume of CTRs. The proposal is part of the Treasury’s continuing effort to increase the efficiency and effectiveness of its anti-money laundering and counter-terrorist financing efforts.

Overview

While banks are increasingly willing to use the exemption process and while anecdotal evidence suggests more banks are using exemptions, use is still limited. Unfortunately, it is not clear if the proposal will achieve its goal but it is worth supporting since it is a step in the right direction.

The major problem with the proposal is that it does not address the two primary barriers that prevent banks from making greater use of exemptions. First, the proposal does not appreciably streamline the overall process because banks will still have to document and maintain internal procedures to back up exemptions. Second, and perhaps more important, the proposal does nothing to eliminate the “regulator risk” of examiner scrutiny and possible criticism for inadvertent errors or failure to adhere to complex requirements. Therefore, while the proposal is well-intended, it is unlikely to reduce the current numbers of CTRs.

Fundamentally, banks do not believe the benefits of using exemptions currently outweigh the associated risks and costs and the proposal does not change that equation. As a result, pending legislation in Congress that would allow exemptions for “seasoned customers” seems more promising.

Background

Since the Bank Secrecy Act was adopted in 1970, banks have been required to report currency transactions over $10,000, a threshold that has not changed in over 35 years. In 1994, the Money Laundering Suppression Act amended the BSA and established a system for banks to exempt certain customers and transactions as a way to eliminate unnecessary CTR filings. However, that attempt has not been as successful as hoped. Banks report they do not use the current exemption system due to regulatory hurdles, concerns about potential increased examiner scrutiny, and the belief that it is substantially easier and less risky to simply file the report. In addition, banks report it is simpler to train tellers and other front-line personnel on the requirement to file without explaining and monitoring for compliance with exemptions.

According to FinCEN, CTRs provide unique, objective, and timely information that is highly useful to a growing number of federal, state, and local law enforcement agencies. Law enforcement agencies point out that information from CTR data is often unavailable from other sources but can provide new leads or corroborate existing information. And, recent advances in technology have enhanced their ability to use the data. Still, many unnecessary CTRs are being filed and the challenge has been identifying and drawing an appropriate line to eliminate them.

Current Exemption Process

Currently, CTR exemptions are divided into Phase I and Phase II exemptions, based on when the rules to implement the 1994 amendments were adopted.

Phase I exemptions apply to:  (1) other banks operating in the United States; (2) government departments and agencies; (3) certain entities that exercise governmental authority; (4) entities whose equity interests are listed on one of the major national stock exchanges; and (5) certain subsidiaries of entities whose equity interests are listed on one of the major national stock exchanges.

Phase II exemptions are eligible non-listed businesses (businesses not listed on one of the major exchanges) or payroll customers. To be eligible, the business must have maintained a transaction account with the bank for at least 12 months, frequently engage in reportable currency transactions, and be incorporated or registered under the laws of the United States or a state. Customers exempted using payroll exemptions are only exempt for their payroll transactions.

A number of entities are not eligible for Phase II exemptions: purchasers or sellers of any type of motor vehicle, including aircraft, farm equipment, or mobile homes; lawyers, accountants, or doctors; auctioneers; operators of charter operations, such as ship, bus, or aircraft charters; gaming operators of any type (except for pari-mutuel betting at racetracks); investment advisors or investment bankers; real estate brokers; pawn brokers; title insurance and real estate closing companies; trade unions; and any other activities specified by FinCEN.

To take advantage of a CTR exemption, the bank must file FinCEN Form 110, Designation of Exempt Person Form, with FinCEN within 30 days after the first transaction which the bank wants to exempt. For a Phase I exemption, the form only has to be filed once but the bank must review the customer and the exemption annually. For a Phase II exemption, in addition to the initial filing, the bank must renew the exemption every other year by refiling.

The Proposal

Eliminating Registration for Phase I Customers. The first change would eliminate the Phase I exemption form for depository institutions; federal, state, or local government entities; or entities exercising governmental authority (the filing requirement would continue for companies listed on one of the major securities exchanges). This could reduce burden by eliminating reporting, review, and paperwork, but it is unlikely many community banks will gain much advantage from the change due to the limited number of community bank customers that fall into this category.

Time Before Phase II Customers Can Be Exempted. The second change would reduce the time that must elapse before a Phase II customer could be exempted. Currently, the customer must maintain a transaction account for at least 12 months before being eligible. Among other problems, banks report that this makes some businesses reluctant to move accounts from other institutions. The proposal would eliminate this 12-month requirement and let an individual bank determine whether to exempt a customer on the basis of the customer’s risk profile. Under this approach, consistent with the general trend towards risk-based compliance, a bank would consider factors such as how long the account had been open, past relationship with the customer, characteristics of the customer’s business, types of business conducted, and where the business operates.

Since some banks prefer a definite timeline, the proposal also advances an alternate possibility where the account would have to be open at least two months before the bank could exempt the customer from CTR filings. However, instead of two months, three months or a full quarter would parallel other activities such as call report filings.

Generally, any time frame shorter than 12 months should make it easier to exempt customers. However, even with a reduced time period, other factors still exist that reduce the attractiveness of the proposal. First, the list of business types not eligible includes many community bank customers. Second, any risk-based approach is subjective by nature and depends on the individual observer and his or her own perceptions and biases. As with any subjective process, community banks are likely to be reluctant to use the process since they are concerned examiners might easily reach a different interpretation. Equally important, community banks can be risk-averse, especially in the current environment where there has been intense examiner scrutiny of BSA compliance.

Overall, community banks report filing a CTR greatly reduces the risk of examiner criticism for non-compliance. Filing also eliminates the amount of time and expense necessary to analyze transactions, perform due diligence, and risk potential penalties for non-compliance. Therefore, while changing the 12 month waiting period is appropriate, it is not at all clear whether community banks are likely to make more extensive use of the exemption process if the change is finalized.

Designation of Exempt Person. Where an exemption form must be filed, the proposal would re-state that the designation must be made within 30 calendar days of the otherwise reportable transaction. Generally, 30 days is ample time to file an exemption and coordinates with other CTR deadlines. However, instead of requiring a filing within 30 days, it would simplify the process if FinCEN let banks exempt a customer at any time during the account relationship. Once the exemption is filed the customer should be exempt from CTRs going forward.

Filing an exemption form is appropriate. First, it ensures the bank conducts the appropriate due diligence for the exemption. Second, it documents the exemption, provides a reference point for when the exemption took effect, and shows a customer was exempt and the CTR was not inadvertently omitted. Finally, it puts FinCEN on notice of the exemption and allows FinCEN the opportunity to take action if needed.

Annual Review. As noted, the proposal would eliminate the annual review requirement for certain Phase I customers, but the annual review would still be required to verify ongoing eligibility for Phase II customers (non-listed businesses and payroll customers). FinCEN believes this annual review for non-eligible businesses and payroll customers provides banks with information helpful to their Suspicious Activity Report (SAR) monitoring requirements. However, while banks would have to review a customer’s status, the filing of a new form every other year to continue the exemption would be eliminated.

This step is not likely to have much impact. The minimal benefit will be eliminating the need to meet the deadline for filing the biennial exemption. However, it will be replaced by a need to develop some alternative to ensure the review is conducted and documented. Community banks report that re-filing is not a burdensome task but documenting compliance with the annual review would be a burden. Ultimately, eliminating the filing is likely to be more beneficial to FinCEN which will no longer have to track and maintain the information.

Revocation. The proposal would change existing rules to make it mandatory to notify FinCEN if a bank decides to no longer exempt a customer (currently the notice is voluntary). The notice would have to be filed within 30 days after the change. Generally, it seems advisable to notify FinCEN when an exemption is being revoked. The filing clearly documents the revocation and puts the government on notice that there has been a change in status for the customer. However, other factors may be in play to merit the attention of law enforcement and so an alternative might be preferable, such as filing a SAR. And, FinCEN should also consider that the more forms involved in the process and the more bureaucratic the process the less likely banks – especially community banks – will use the process. As one community banker commented, “BSA compliance is difficult enough when you consider what’s mandatory. Why would a bank want to add to that burden by taking on something that is voluntary?”

Change in Control. Currently, banks must file a change in control notice on any Phase II customers if it knows, or should know on the basis of its records, that there has been a change in control of the customer. The proposal would require banks to file an amended designation of exempt person form by March 15 of the calendar year following every second year in which the bank knew or should have known of the change in control. As an alternative, FinCEN is considering only requiring a change in control notice within 30 days after the bank is aware of the change.

Fundamentally, the proposed approach to change in control notices is contrary to the goal to simplify the process. While the concept seems workable, the “should have known” standard is problematic since it is open to interpretation and rife with opportunities for disagreement with examiners. If required, a change in control notice should only be filed once when the change of control comes to the attention of the bank.

Conclusion

While FinCEN’s efforts to try to make the exemption process more appealing are welcome, it is not likely that the proposed changes will be enough to sway many banks to make greater use of the exemption process. First, streamlining the Phase I exemptions are unlikely to apply to most community bank customers. Second, community banks are still concerned about the use of the exemption process since it complicates CTR compliance and also creates a process that examiners can review and critique, thereby adding to regulator risk. The risk of improperly using exemptions or not correctly monitoring, documenting, and filing is far outweighed by simply filing a CTR, especially for most community banks. Under current exemption requirements, avoiding exemptions avoids the problems entirely. Unfortunately, the proposed changes do not affect those concerns and thus will not overcome those barriers. Third, while some burdens are eliminated, the proposal adds others and, on balance, the overall burdens associated with exempting customers may actually be greater, not less.

FinCEN’s effort to reduce paperwork is welcome. However, it is important that FinCEN recognize that moving to a more risk-based approach increases the internal requirements for documentation, monitoring, and other efforts to demonstrate compliance. While reduced paperwork may ease the requirements for FinCEN, the burden is merely shifted to the banks. Fundamentally, until the exemption process becomes simpler and less burdensome than filing a CTR, banks – especially community banks – are not likely to use the exemption process.