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Date: March 18, 2011 Prepared By: S. Marshall Martin, Esq.

Institute of Internal Auditors & Association of Certified Fraud Examiners 2011 Fraud Conference The Convergence of Fraud & AML. Date: March 18, 2011 Prepared By: S. Marshall Martin, Esq. Enterprise Risk Executive & Co-General Counsel City National Bank of Florida. Agenda.

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Date: March 18, 2011 Prepared By: S. Marshall Martin, Esq.

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  1. Institute of Internal Auditors & Association of Certified Fraud Examiners 2011 Fraud Conference The Convergence of Fraud & AML Date: March 18, 2011 Prepared By: S. Marshall Martin, Esq. Enterprise Risk Executive & Co-General Counsel City National Bank of Florida 1

  2. Agenda 2

  3. I. Definitions & Types of Fraud • American Jurisprudence, Second Edition • "Fraud" is an elusive and shadowy term. • "Fraud," is not limited to misrepresentations and misleading omissions, embraces all of the multifarious means that human ingenuity can devise and that are resorted to by one individual to gain advantage over another by false suggestions or by suppression of truth. • In fact, the fertility of people's invention in devising new schemes of fraud is so great that courts have always declined to define the term, reserving to themselves the liberty to deal with fraud in whatever form it may present itself. • Handful of fraud definitions: • a misrepresentation or suppression of the truth made with the intention either to obtain an unjust advantage for one party or to cause loss or inconvenience to the other. • malfeasance, a positive act resulting from a willful intent to deceive. 3

  4. I. Definitions & Types of Fraud (cont.) • Handful of fraud definitions (cont.): • An intentional perversion or concealment of the truth for the purpose of inducing another in reliance upon it to part with some valuable thing or to surrender a legal right. • "Fraud" is malfeasance and, as such, is a positive act resulting from a willful intent to deceive. • Common Elements: • Making a false statement of a material fact • Knowledge by person making the statement that the statement is untrue • Untrue statement made with intent to deceive • Justifiable reliance on the part of the victim • Injury to the victim 4

  5. I. Definitions & Types of Fraud (cont.) • Florida Statutes (Chapter 817 Fraudulent Practices)(sampling only): • 817.02 Obtaining property by false personation • 817.03 Making false statement to obtain property or credit • 817.233 Burning to defraud the insurer • 817.545 Mortgage fraud • 775.01 Common law of England.— “The common law of England … shall be of full force in this state where there is no existing provision by statute on the subject.” • Federal Laws on Fraud (sampling only): • 18 USC § 38. Fraud involving aircraft or space vehicle parts in interstate or foreign commerce • 18 USC § 157.   Bankruptcy fraud • 18 USC § 288.   False claims for postal losses • 18 USC § 1343.   Fraud by wire, radio, or television • 18 USC § 1344. Bank fraud • 18 USC § 1347. Health care fraud • 18 USC § 1348. Securities and commodities fraud • 18 USC § 1543. Forgery or false use of passport 5

  6. I. Definitions & Types of Fraud (cont.) • Common frauds we see: • Ponzi schemes • Elder fraud • Medicare fraud schemes • Mortgage fraud (liars loans) • Boiler room securities trading • Tax evasion • Check & wire fraud • Identity theft • Make no mistake, what we are seeing is organized crime where fraud is the business!!! 6

  7. II. Bank Secrecy Act (BSA) • Money laundering: • In a nutshell, it is the process of taking the proceeds of criminal activity and making them appear legal. • Stages of Money Laundering: • Placement.Placement involves getting the illicit funds into the financial system. In the case of currency paid for illegal narcotics, the need is obvious. Currency is anonymous, but it is difficult to handle, hard to hide, takes time to move, and attracts attention. If the crime involved creates non-current proceeds (e.g., the proceeds of a fraudulent stock sale or public corruption), placement occurs when the proceeds first come under the criminal’s control. • Layering.The launderer’s job is not over when money is placed. Large amounts of unexplained value also tends to attract attention. Funds must be moved and broken up to hide their true origin and to suggest a legitimate source. This process is call “layering”. Through layering, the launderer can move funds from one nation, financial institution, or form through two or three others in a matter of moments, given the speed at which transactions can now be conducted via high-speed computer networks. • Integration.Once funds are layered sufficiently, they can be put to use by the criminals who have control over them. The funds are now no longer being moved simply to obscure their origin and true ownership but to refinance the criminal’s activities. 7

  8. II. BSA (cont.) • Terrorist financing: • Terrorist acts of September 11 brought this issue to the forefront • Motivation is ideological as apposed to profit seeking • Intent is to intimidate a population or compel a government to act or abstain from acting through the threat of violence • Sources of funding may (e.g., extortion, kidnapping, narcotics, fraud) or may not (e.g., charities & foreign government sponsors) involve criminal activity • Sometimes involves use of informal transfer systems or hawalas • Often methods are the same as money launders, for example: currency smuggling, structured deposit or withdrawals, prepaid cards and use of funds transfers 8

  9. II. BSA (cont.) • Enacted in 1970 • The BSA is a law and its name is actually a misnomer because it imposes record keeping and reporting requirements rather than requiring bank secrecy. • As part of the effort to fight organized crime and drug dealing, federal law requires businesses to report large cash transactions to the government. • It also requires certain businesses to maintain records of various transactions (cash and other). • The theory behind the BSA is that reporting of cash transactions would curtail illegal businesses by impeding their ability to launder money. 9

  10. II. BSA (cont.) • Purpose of BSA (31 USC 5311) • “is to require certain reports or records where they have a high degree of usefulness in criminal, tax, or regulatory investigations or proceedings, or in the conduct of intelligence or counterintelligence activities, including analysis, to protect against international terrorism. ” • Historical development of the BSA & AML legislation: • Constitutionality of BSA challenged in 1974 • California Bankers Assoc. challenged constitutionality, Supreme Court held: the reporting and recordkeeping requirements did not violate the 4th amendments rights (not an illegal search or seizure). • Tax Reform Act of 1984 • Persons engaged in trade or business required to report to IRS (Form 8300) receipt of more than $10,000 in currency. • 1986 Money Laundering Control Act • Criminalized the act of money laundering; • Prohibited structuring transactions to evade CTR filings; and • Introduced civil and criminal forfeiture for BSA violations. 10

  11. II. BSA (cont.) • Historical development of the BSA & AML legislation (Cont.): • 1988 Money Laundering Prosecution Improvement Act • Expanded the definition of financial institution to include businesses such as car dealers and real estate closing personnel and required them to file reports on large currency transactions; and • Required the verification of identity of purchasers of monetary instruments over $3,000. • 1992 Annunzio-Wylie Money Laundering Suppression Act • Added Sections 18(w) to FDI Act which provides for the revocation of federal deposit insurance of institutions convicted of certain money laundering crimes (AKA Death Penalty); • Required Suspicious Activity Reporting (safe harbor for reporting); and • Required verification and recordkeeping for wire transfers. • 1994 Money Laundering Suppression Act • Required banking agencies to develop anti-money laundering examination procedures and streamlined CTR exemption process. 11

  12. II. BSA (cont.) BSA in a nutshell • Reports Required (Please note: other reports may be required): • Suspicious Activity Report(SAR, FinCen Form TD F 90-22.47) • Currency Transaction Report(CTR, FinCEN Form 104) • Currency transaction greater than $10,000 in one day • Report of International Transportation of Currency or Monetary Instruments (“CMIR”)(FinCen Form 103) • Currency or other monetary instruments in an aggregate amount exceeding $10,000 on any one occasion • Records Required to be Maintained • Bank records (e.g., information contained in wires, statements, ledgers, each check drawn on the bank (over $100), each debit (over $100), etc.) • Retention of Records (generally 5 years) • Establishment of Anti-money Laundering / Customer ID Programs • Structuring is a crime • Structuring is any activity designed to specifically evade financial reporting requirements (e.g., splitting deposits, payments, etc.) 12

  13. II. BSA (cont.) BSA Civil / Criminal Penalties • Injunction • Civil Penalties: • (i) amount of the currency or monetary instrument transported / involved in the transaction (forfeiture); or • (ii) not more than the greater of the amount (not to exceed $100M) involved in the transaction (if any) or $25M • Criminal Penalties:fine not to exceed $250M and/or imprisonment for up to 5 years or while committing another crime (e.g., money laundering) fine not to exceed $500,000 and/or up to 10 years imprisonment • Special measures violations : 2 times amount of transaction but not more than $1,000,000 • §311 of USA Patriot Act: Special measure for jurisdictions, financial institutions, or international transactions of primary money laundering concern • Bank regulatory perspective: Interagency Statement on Enforcement of BSA/AML (failure to establish or correct, regulator shall issue cease & desist) 13

  14. III. USA PATRIOT Act • 2001 Uniting and Strengthening America by Providing Appropriate Tools to Restrict, Intercept and Obstruct Terrorism Act (USA PATRIOT Act) An act passed shortly after the September 11 Twin Tower tragedy to deter and punish acts in the US and around the world, to enhance law enforcement investigatory tools … • Addressed multiple areas of law and law enforcement, below are some examples: • Sample of Depth of Act • Authority to intercept wires • Criminal information sharing between agencies • Criminalized illegal money transmission (informal value transfer systems such as hawalas) • Enhanced immigration provisions • DNA identification • Disclosure of education records • Improved intelligence (CIA, FBI, Secret Service, etc.) • Title III, International Money Laundering Abatement and Anti-terrorist Financing Act of 2001 • Special measures for jurisdictions, financial institutions, or int. transactions of primary money laundering concern (§ 311) • Special due diligence for correspondent accounts and private banking accounts (§ 312) • Prohibition on US correspondent accounts with foreign shell banks (§ 313) • Forfeiture of funds in US inter bank accounts (§ 319) • Customer Identification Programs (§ 326) • Anti-Money Laundering programs (§ 352) • Securities brokers & dealers required to report suspicious activities (§ 356) • Increase in civil & criminal penalties for money laundering (§ 363) • Report CTR by non-financial businesses (§ 365) to FinCen & expanded definition of “coin & currency” 14

  15. IV. Crime of Money Laundering Federal Crime of Money Laundering • 18 USC 1956: Laundering of monetary instruments • Prongs (i) & (ii): if you know that property involved represents proceeds from some form of unlawful activity and you knowingly conduct(i) financial transactions and/or (ii)transmit/transport monetary instruments from or to the U.S. with: • the intent to promote a specified unlawful activity and • knowledge that such action is made to conceal or disguise the (1) nature, (2) location, (3) source, (4) ownership or control, (5) or to avoid transaction reporting requirements under Federal or State law: • You shall be fined up to $ 500,000 or twice the value of the property involved in the transaction, whichever is greater and/or imprisoned for not more than 20 years. • Prong (iii) (Used in Sting Operations): if you intend to do any of the above, conduct, or attempt to conduct a financial transaction involving property represented to be proceeds of a specified unlawful activity: • You shall be fined and/or imprisoned for not more than 20 years. 15

  16. IV. Crime of Money Laundering (cont.) Federal Crime of Money Laundering (cont.) • 18 USC 1957: Engaging in monetary transactions in property derived from specified unlawful activity • If you knowingly engage or attempt to engage in a monetary transaction that involves criminally derived property that is valued greater than $10,000 and is derived from a specified unlawful activity: • You may be fined and/or imprisoned for not more than 10 years. • The Government is not required to prove that you knew that the property was derived from an offense that was a specified unlawful activity. • 18 USC 1960: Prohibition of unlicensed money transmitting business • If you knowingly conduct, control, manage, supervise, direct, or own all or part of an unlicensed money transmitting business: • You shall be fined and/or imprisoned for not more than 5 years. 16

  17. IV. Crime of Money Laundering (cont.) Key elements of criminal statutes: • Knowing/knowledge, includes: • Willful blindness • You are imputed knowledge if you knew that the property involved / represented proceeds from some form of activity that constitutes a felony under State, Federal, or Foreign law. • It is not necessary that you knew exactly which form of activity. • Conducts: This includes initiating or concluding OR participating in initiating or concluding the transaction. • Specified Unlawful Activity: Any form of crime that you can imagine (e.g., drug dealing, murder, kidnapping, robbery, smuggling, bribery, arson, bank fraud, securities fraud, exploitation of children, tampering with witnesses, etc.). 17

  18. V. Concept of Convergence • What does convergence of fraud and AML mean? • Convergence means: the merging of distinct technologies, industries, or devices into a unified whole. • True convergence would mean all fraud and AML functions, systems, people, and processes would fall under one leader. • From a SAR filing perspective, we are de facto converged (see SAR form below): 18

  19. V. Concept of Convergence (cont.) SAR activity by the numbers ∑ = 36.39% 19

  20. V. Concept of Convergence (cont.) • Challenges • Support from the top • Different aims / objectives of the fraud and AML department • Focus of one is to reduce or eliminate losses • Focus of other is to prevent the use of the organization for illicit purposes • Different skill set of department personnel • No perceived need to integrate • Fraud and AML manifest differently and therefore the need for different technologies will remain • IT infrastructure and data base issues (the bigger the entity, the bigger the problem) • Limiting certain information (e.g., Grand Jury Subpoenas, National Security Letters) 20

  21. V. Concept of Convergence (cont.) • Benefits • Potentially reduced staffing levels • Leveraging systems (best example would be case management) • Manage financial crime and related risks across the enterprise and not in silos • Improving communication across departments (especially with respect to SARs, for example: analysis, decision making, etc.) • Potential improvement in efficiency and effectiveness (removing redundancies) • Improving transparency between investigators (especially if both departments share case management) • Cross training and skill development • Limit redundant or duplicative services (hardware/software/vendor cost reductions) 21

  22. V. Concept of Convergence (cont.) • Risk of doing nothing / regulator expectations • Protecting the reputation of your organization • Can be substantial exposure to civil and criminal liability (big fraud cases: Madoff, Stanford, Rothstein – role of financial institution played) • Working in silos will get you in trouble • Recent OCC “written agreement” stated: • “Within sixty (60) days, the Board shall develop a plan of action, including a timetable, for improving case management system functionality to include, at a minimum, the ability to aggregate related cases based on the identity of the initial beneficiary and/or depositor … if that initial beneficiary or depositor is a Bank customer.” • Comments by Jim Fries, Director of FinCEN on fraud/AML over the years: • Leveraging resources • Creating efficiencies • Logic of close coordination among those with anti-money laundering and anti–fraud responsibilities 22

  23. V. Concept of Convergence (cont.) • Other considerations and leverage points • SAR sharing • Vertical (Sharing with Head Office & Controlling Companies, 1/20/2006) • Parent or head office can be foreign • Wise to enter into confidentiality and indemnity agreement • Horizontal (Sharing with Affiliates, 11/23/10) • Affiliate means any company under common control with or controlled by that depository institution • Affiliate must be subject to SAR regulation • Wise to enter into confidentiality and indemnity agreement • 314(b) information sharing on: • Possible money laundering; or • Terrorist financing • NOTE: Notify your peers at eligible institutions of the risks you are seeing. 23

  24. V. Concept of Convergence (cont.) • Other considerations and leverage points (cont.) • 314(b) information sharing (cont.): • FinCEN Guidance on Scope of Permissible Information Sharing Covered by Section 314(b) Safe Harbor of USA PATRIOT Act: • The SUAs listed in 18 U.S.C. § § 1956 and 1957 include an array of fraudulent and other criminal activities. • Information related to the SUAs may be shared appropriately within the 314(b) safe harbor to the extent that the financial institution suspects that the transaction may involve the proceeds of one or more SUAs and the purpose of the permitted information sharing under the 314(b) rule is to identify and report activities that the financial institution “suspects may involve possible terrorist activity or money laundering.” • Red Flag program • Update program, its Red Flags, & key contacts/owners periodically • Create a contact point for suspicious referrals (e.g., BSA Department) • Referrals from employees • Relationships with law enforcement • Relationships with fellow fraud professionals (invaluable) • Measuring success (What are the metrics?) 24

  25. VI. Closing Thoughts • Inter-relationship between fraud and AML is clear and unquestionable • Convergence has 1 meaning but many practical applications, for example: • Consolidating or sharing information across risk points or departments • Improved transparency and reporting to the board should be done across AML and fraud statistics simultaneously (give the full impact) • Share resources (e.g., case management) • Explore collective use of data sources • Tremendous opportunities exists in leveraging systems, people, resources, data, etc. • Leverage vertical and horizontal sharing of SARs • Increase use of 314(b) • Develop close ties with law enforcement • Develop close ties with your peers 25

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