Money Laundering in the Securities Industry

• Publication year: 1997
• Pages: 57
• Citation: Vol. 26 No. 8 Pg. 57

26 Colo.Law. 57 Colorado Lawyer 1997.

1997, August, Pg. 57. Money Laundering in the Securities Industry

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57

Vol. 26, No. 8, Pg. 57

The Colorado Lawyer
August 1997
Vol. 26, No. 8 [Page 57]

Specialty Law Columns
Criminal Law Newsletter
Money Laundering in the Securities Industry
by Robert L. Arendell

Historically, using the term "money laundering" invoked images of narcotics deals, the Mafia, or schemes cooked up in warehouses. The future of money laundering convictions, however, may change that image to include the corridors of America's most reputable brokerage firms The reason is simple: brokers can commit the crime of money laundering by simply performing their duties as securities brokers

This article discusses what securities brokers, and their lawyers, need to know to avoid this potential--and potentially devastating--trap

A Thin Line

Imagine this scenario: Mr. I.R. is a registered securities broker with a successful career, honestly earned by working countless early mornings and late nights. A new customer asks Mr. I.R. to invest $500,000, which the customer says is the proceeds of a real estate closing in Vail. The customer tells Mr. I.R. that the buyer is a Denver engineer. The money is given to Mr. I.R. as $100,000 in cash and a $400,000 wire transfer from an account in the Cayman Islands. The customer asks that the money be placed in speculative investments. As the broker, does Mr. I.R. accept the money and open an account for the new customer? After all, what harm is there in performing his job has a broker?

In real life, accepting the customer's money based on the facts above would end Mr. I.R.'s career, or worse still, put him in a federal prison.

Securities brokers increasingly must walk a thin line. On one hand, a broker who fails to learn enough about a customer and conducts business with him or her violates the duty to "know your customer" and subjects himself or herself to disciplinary action and civil suit. On the other hand, a broker who learns too much about a customer, in particular that the customer is engaged in illegal activities, and still conducts business with that customer, may violate federal laws prohibiting money laundering.

Brokers, and their lawyers, can avoid the perils of the federal money laundering statutes by adhering to three basic rules: (1) brokers must know their customers before doing business with them; (2) if a broker believes, or is given reason to believe, that a customer is trying to invest the proceeds of unlawful activities, a broker should refuse to conduct business with that customer; and (3) brokers must be mindful of current and forthcoming reporting requirements.

The remainder of this article is divided into three sections. The first section discusses the first rule and the consequences of not knowing the customer. The second section discusses the second rule, the crime of money laundering, and the repercussions of knowing the customer too well. Finally, the third section addresses government regulations that may be extended to brokers, requiring them to report "suspicious transactions."

Know the Customer

Securities brokers (registered representatives) have a duty to know the customer. This duty requires registered representatives to have knowledge of each client's investment objectives, needs, and circumstances (personal and financial). As set forth, in relevant part, by Rule 405 of the New York Stock Exchange ("NYSE"):

Every member organization is required . . . to [u]se due diligence to learn the essential facts relative to every customer, every order, every cash or margin account accepted or carried by such organization. . . .1

Failing to adhere to the know your customer rule can spell the demise of a broker's career. At one level, the regulatory/ enforcement bodies within the NYSE, NASD, and other self-regulatory organizations possess the authority to fine, censure, and even suspend or bar brokers from membership.2 At a second level, customers enforce the "know your customer" rule through private court actions and arbitration proceedings.3 Although it is commonplace for customers who have made bad investment decisions to blame their brokers, there are occasions when brokers simply recommend securities that are unsuitable for the particular customer. In those cases, most of the fault generally can be attributed to the broker's lack of effort to know the customer.

In practice, knowing the customer means asking questions. In particular, brokers must ask questions regarding the customer's sources of funds, types of other investments, net worth and related financial information, investment experience, and investment objectives. These questions are necessary to ensure that the broker understands the type and quantity of securities that are suitable for the particular customer. A millionaire with a steady income is more suitable to take risk on some investments than a person living on a limited, fixed income.

Whether because of mere oversight, haste, or fear of embarrassing the customer, some brokers fail to ask enough questions. For example, taken from a real-life situation, a customer approaches a broker and requests that the broker purchase securities. The customer hands the broker a third-party check. The broker accepts the money and fills out the required paperwork for opening an account.

When the broker's supervisor begins a review of the paperwork, he sits the broker down and asks a number of questions:

Whose money is it really?

How is the third party employed?

What is the third party's annual income?

Is the third party looking for short-term gains or long-term security?

What other assets does the third party have?

The broker does not have answers, let alone...