Client Alerts

SEC Civil Penalty Against Charles Schwab Reflects New Trend in Enforcement of SAR Requirements

By: Alan M. Wolper and Frances Floriano Goins

About: Financial Services, Broker-Dealer & Investment Litigation

The question of whether it is necessary to file a suspicious activity report (SAR) recently became more complex for members of the financial services community. In July, Charles Schwab agreed to pay a $2.8 million civil penalty to the U.S. Securities and Exchange Commission (SEC) as a result of failing to file SARs on a number of questionable transactions that were conducted by independent investment advisers that Schwab terminated from its platform. While this matter is noteworthy in part for the size of the penalty, it also reflects a growing trend by at least one regulator – the SEC – to focus less on a financial institution’s anti-money laundering (AML) processes and more on its ultimate decision whether or not to file a SAR. 

Requirements for Suspicious Activity Reporting
The Bank Secrecy Act (BSA), as amended by the USA PATRIOT Act, requires financial institutions to monitor for and report suspicious activities when warranted. This rule requires a SAR to be filed when the financial institution knows, suspects, or has reason to suspect that a transaction of at least $5,000 involves money from illegal activity, is being conducted to disguise such funds or evade the requirements of the BSA, has no business or apparent lawful purpose, or involves the use of the financial institution to facilitate criminal activities.

Based on this language, determining whether some circumstances require filing a SAR can become the subject of intense debate – and that debate occurs often. Financial institutions filed more than 916,000 SARs in 2017 and are on track to file 940,000 this year, according to the Department of the Treasury’s Financial Crimes Enforcement Network.

A Trend Emerges
Historically, the focus of regulators in their AML enforcement actions has been on whether the financial institution had proper AML procedures in place in order to timely spot suspicious activity, to investigate the suspicious activity promptly and thoroughly, and to document that process – not whether the financial institution actually filed a SAR. This proposition was reflected in Sterne Agee, a FINRA OHO decision where the hearing panel noted, “The decision to file a SAR is an inherently subjective judgment. Examiners should focus on whether the bank has an effective SAR decision-making process, not individual SAR decisions.”

While the failure to file a SAR could still be questioned under the reasoning of Sterne AgeeSchwab is the latest in a line of SEC cases that turn away from Sterne Agee by caring more – or at least as much – about whether a SAR was filed as opposed to whether the financial institution had a reasonable supervisory system in place that allowed it to spot suspicious circumstances. Other cases showing evidence of this trend include Wells Fargo agreeing to pay $3.5 million to the SEC in November 2017 for its failure to file or timely file at least 50 SARs, of which a majority related to continuing suspicious activity, and Aegis Capital Corp. agreeing to pay a $750,000 civil penalty in March 2018 for its failure to file SARs on hundreds of transactions even when it specifically identified AML red flags with these transactions through its written supervisory procedures. 

How to Move Forward
The decision whether to file a SAR is an important one, and may be more uncertain as this trend continues. While in the past many thought the actual decision to file a SAR or not was less of a concern, this recent line of cases demonstrates the need not only to maintain AML supervisory procedures, but also to carefully evaluate the decision of whether to file a SAR.

Further, firms should be aware of the potential for long-awaited reform legislation that could impact the requirements of the BSA. The Counter-Terrorism and Illicit Finance Act, which was introduced in the U.S. House of Representatives in June, proposes doubling the dollar threshold for SARs from $5,000 to $10,000. While this bill is only in the first stage of the legislative process, its introduction reflects a desire by legislators to modernize and streamline the framework of the BSA, as its current SAR thresholds have not been amended since they were established in 1996.