To Catch A Thief

Is your firm involved in the illicit transfer of funds between drug traffickers, international smugglers or terrorists? Absolutely not, you declare? Well, according to a recent report written by the research and consulting firm Celent Communications, $123.4 billion was laundered in the United States in 2002. What's more, securities and investment firms - including broker/dealers, private banks, mutual funds and hedge funds - were the conduit for 25 percent of those criminal transactions.

To combat this growing problem, the Congress, in October 2001, approved the USA Patriot Act - a comprehensive set of anti-money laundering requirements and regulations.

The act requires all U.S. financial-services firms to appoint an AML compliance chief and develop a formal AML program, as well as to build an employee-training program and create an internal-audit function that can measure the effectiveness of a firm's AML strategy. Moreover, the act increased the fine for firms caught laundering money from $100,000 to $1 million, and threatened AML chief compliance officers with jail time.

For financial-services firms, meeting the act's requirements will be a huge challenge in 2003, because, on top of developing a program, many will have to select and install a comprehensive AML-software solution.

"I think the major challenge is implementing the capability to monitor transactions, to keep track of what their customers are doing across all of their business lines," says Neil Katkov, the Celent analyst who authored the firm's Sept. 2002 report on AML.

"It's a challenge on the scale of a customer-relationship-management-type implementation. They have to take all of their core systems and feed them into AML technology, so that they can monitor and analyze everything that's going on."

The securities and investment firms facing the most difficult AML challenge, he says, are hedge funds and "the private client part of investment banks." The private-client divisions of banks face an uphill battle monitoring and analyzing funds, says Katkov, because "a lot of what they do involves offshore banking, tax sheltering ... and overseas trading."

Katkov says that hedge funds, on the other hand, have to start from ground zero on AML, because they previously were subject to no money-laundering regulations. "The Patriot Act is the first major regulatory protocol they have had to face, and I think it will be difficult for them to identify who among their wealthy and favorite clients might actually be criminals," he says.

That said, Katkov expects the number of financial-services firms implementing AML technology to rise significantly in 2003.

Back in October 2001, he says, only 20 percent of securities and investment firms had some type of AML software. But, by the end of next year, Katkov predicts that "100 percent" of large broker/dealers will have installed an AML system or be close to completing an AML rollout. However, he says, that, in contrast, smaller shops - manned by 10 people or less - may not adopt any AML technology.

Fimat USA, a hybrid broker/dealer-futures-commission merchant, is one of a few firms that have already met all the requirements of the Patriot Act.

Gary Dewaal, senior executive vice president and general counsel for Fimat USA, says that one of the reasons Fimat is ahead of the game is because it is a subsidiary of the French bank Societe Generale - a bank which is subject to certain AML regulations, such as the requirement to report suspicious activities under the U.S. Treasury's Bank Secrecy Act of 1970.

Dewaal says that Fimat has already built an internally developed screening system that automatically checks clients against government watch lists. The firm, he says, is also currently searching for a comprehensive, off-the-shelf transaction-monitoring and analysis system.

Fimat, says Dewaal, is installing technology and following AML procedures because it could not withstand the damage of being involved in a money-laundering scandal. "By the time the regulators will fine you, that's the least of your problems. The hit that you would have taken to your reputation - and the pension funds and governments that will not do business with you, because you're associated with money launderers - will already have caused havoc to your business," he says.

For a securities firm, unfortunately, discovering money laundering is typically an incredibly difficult task. In part, that's due to the fact that by the time an illegal transfer of funds has reached a securities firm, says Celent's Katkov, it may have already been "washed" at a commercial bank.

"I think it's going to be virtually impossible to catch money laundering at a securities firm," he says. "However, by implementing AML software, securities firms are going to be able to get a much better handle on trading irregularities, including insider trading."

Despite the fact that chances of catching a money launderer are slim, Celent projects that banks, broker/dealers and insurance companies in the United States will collectively spend a total of $10.9 billion on AML initiatives through 2005.

Software and hardware will account for 6 percent of that total ($695 million), while IT maintenance will account for 30 percent ($3.3 billion). The remaining 64 percent of AML spending will be allocated to employee training, reporting and compliance, the report states.

Fimat's Dewaal says those spending projections reflect the fact that the key to developing a successful AML program is to combine technology with human know-how.

"I once went to an AML training session. And the leader of that session said, 'Just like we're sitting in a room, studying AML, a bunch of money launderers are sitting in a room, studying your policies and procedures," he recalls. "You develop something, they anticipate it. You put in a program that looks at XYZ, they trade ABC. They are always one step ahead. So, to me, the key is always going to be a combination of human input and computer programs. Any (AML program) that is designed to rely on (either humans or technology) exclusively is going to fail," Dewaal cautions.