Alternative Trading Systems: Anti-Money Laundering Program Essentials

The Importance of a Strong AML Program

In today’s financial landscape, the fight against money laundering has become a critical concern for alternative trading systems. As these platforms grow in popularity and complexity, they face increasing scrutiny from regulatory bodies worldwide. Building a robust Anti-Money Laundering (AML) program is not just a legal requirement; it’s a vital step to protect the integrity of the financial system and maintain trust among stakeholders.

This article delves into the essential components of creating a strong AML program for alternative trading systems:

• the current regulatory environment
• the process of conducting thorough risk assessments
• the importance of fostering a culture of compliance
• effective methods to monitor and report suspicious activities

The Regulatory Landscape for ATS and Anti-Money Laundering

The regulatory environment for alternative trading systems and anti-money laundering has become increasingly complex and demanding. As financial crime evolves, regulatory bodies continue to strengthen their requirements and close loopholes to combat money laundering effectively.

SEC Requirements

The Securities and Exchange Commission (SEC) regulates alternative trading systems, computerized systems that match buy and sell orders of securities. While not classified as a national securities exchange, an alternative trading system must register as a broker-dealer and comply with associated obligations, including FINRA membership and adherence to FINRA rules. Alternative trading systems must submit Form ATS to the SEC, detailing how their system qualifies as an alternative trading system, and outlining procedures to monitor compliance with public display and fair access requirements.

FinCEN Guidelines

The Financial Crimes Enforcement Network (FinCEN) plays a crucial role in shaping AML regulations. FinCEN aims to strengthen and modernize financial institutions’ AML programs by requiring firms to:

• Require risk-based AML programs with mandatory risk assessments
• Incorporate government-wide AML priorities into institutional programs
• Promote consistency across different types of financial institutions
• Encourage responsible innovation in AML programs

Industry Best Practices

To navigate this complex landscape, financial institutions should:

• Stay informed about new laws, rules, and regulations
• Regularly update Written Supervisory Procedures (WSPs) and compliance programs
• Implement risk-based AML programs tailored to their specific needs
• Foster a culture of compliance within the organization
• Utilize technology to enhance AML efforts while managing risks effectively

By adhering to these practices, alternative trading systems can better position themselves to meet regulatory requirements and contribute to the ongoing fight against financial crime.

Conducting a Thorough AML Risk Assessment

A comprehensive AML risk assessment is crucial for financial institutions to make informed decisions, strengthen controls, and allocate resources efficiently. This process involves identifying potential vulnerabilities, assessing the customer base, and evaluating transaction patterns.

Identifying Potential Vulnerabilities

To identify potential vulnerabilities, organizations should consider various risk factors:

• Geography. Assess the risk associated with the institution’s location and its customers’ locations. Foreign-based customers in high-risk jurisdictions pose increased risk compared to domestically based ones.
• Channels. Evaluate the methods used for financial transactions. New channels, like internet-based account opening, present unique challenges and must be assessed for additional risks.
• Products and Services. Analyze the inherent and residual risks associated with products and services being offered. As new products and services are offered, remember to conduct a detailed analysis to outline any AML risks associated with these services and products. Likewise, retrospective reviews of existing products and services should be conducted periodically to determine if any new risks exist.

Assessing Your Customer Base

Customer due diligence (CDD) and enhanced due diligence (EDD) are essential components of assessing the customer base:

• Implement robust CDD procedures to understand customers and their associated risks.
• Apply EDD measures to high-risk customers, including collecting detailed information, identifying beneficial owners, and defining the purpose of the business relationship.
• Conduct sanction and politically exposed person (PEP) screenings during the onboarding process.

Evaluating Transaction Patterns

Monitoring and analyzing transaction patterns is vital for detecting unusual activities:

• Review the volume, frequency, and types of transactions.
• Compare the number of international wires to domestic ones.
• Assess the number of currency transaction reports and suspicious activity reports (SARs) filed annually.
• Implement transaction monitoring systems to detect deviations from expected behavior.

By conducting a thorough AML risk assessment, financial institutions can effectively identify, monitor, and mitigate potential money laundering threats, ensuring compliance with regulatory requirements and contributing to the fight against financial crime.

Build a Strong AML Team and Culture

Hire Qualified Personnel

To build a robust Anti-Money Laundering (AML) program, organizations must prioritize hiring qualified personnel. AML/KYC Analysts play a crucial role in maintaining the integrity of financial systems. Strong analytical skills, meticulous attention to detail, and excellent communication abilities are essential. Proficiency in Microsoft Excel and a solid understanding of financial regulations, particularly those relating to AML and KYC (Know Your Customer), are also vital.

Establish Clear Roles and Responsibilities

Clear roles and responsibilities are fundamental to an effective AML program. Organizations should appoint a designated Bank Secrecy Act (BSA) compliance officer responsible for day-to-day oversight of compliance. This individual must be approved in writing by senior management and should submit contact information through the FINRA Contact System. The compliance officer’s duties include ensuring the program is reasonably designed to detect and report suspicious activity, achieve compliance with AML rules, and implement a risk-based Customer Identification Program (CIP).

Foster A Compliance-Focused Environment

Creating a compliance-focused culture is essential for the success of an AML program. This culture should permeate the entire organization, from leadership to frontline employees. Key elements include:

• Leadership commitment: Senior management must set the tone, emphasizing the importance of ethical conduct and regulatory adherence.
• Clear policies and procedures: Establish well-defined guidelines to mitigate risks and empower employees to make informed decisions.
• Ongoing employee training: Provide regular training sessions to equip staff with the necessary knowledge and skills to navigate complex regulatory landscapes.
• Effective communication channels: Implement confidential reporting mechanisms to encourage the reporting of potential compliance issues without fear of retaliation.
• Recognition and accountability: Reward compliant behavior while holding individuals accountable for non-compliance.

By implementing these strategies, organizations can build a strong AML team and foster a culture that prioritizes compliance and ethical conduct.

Monitoring and Reporting Suspicious Activities

Implementing Effective Surveillance Systems

Financial institutions must implement robust surveillance systems to detect and prevent money laundering activities. These systems should utilize data-driven analysis and AI-enhanced tools to process vast amounts of information rapidly. AI-driven AML surveillance tools can identify complex patterns and anomalies that may indicate illicit financial activities. By automating routine tasks, these systems reduce manual workload and allow compliance teams to focus on strategic activities.

Recognizing Red Flags

When monitoring trading activity within an alternative trading system, certain patterns and behaviors may raise red flags, signaling potentially suspicious activities that could warrant the filing of a Suspicious Activity Report (SAR). Alternative trading system platforms, which operate outside of traditional exchanges, are often used for large or private transactions, making them attractive venues for market manipulation or other illicit activities. A vigilant approach to identifying irregularities is crucial for maintaining the integrity of the financial markets and ensuring compliance with regulatory requirements.

Unusual Trading Patterns

One key indicator of suspicious activity within an alternative trading system is the presence of unusual trading patterns that deviate from typical market behavior. For example, if a trader consistently places large orders that are immediately canceled before execution, it may suggest an attempt to manipulate market prices, a practice known as “spoofing.” Similarly, a sudden and unexplained increase in trading volume, especially in illiquid securities, could indicate an attempt to artificially inflate or deflate stock prices, potentially for the purpose of insider trading or other forms of market manipulation.

Unknown or unverified participants engaging in large or frequent transactions

Another red flag is the involvement of unknown or unverified participants engaging in large or frequent transactions. In an alternative trading system where participants may have less stringent identity verification processes compared to traditional exchanges, this could signal money laundering or other illegal activities. If a participant is consistently engaging in trades that lack a clear economic purpose or involve offshore entities in jurisdictions with lax regulatory oversight, these transactions could warrant further investigation and a potential SAR filing. Financial institutions must carefully scrutinize such activities, considering the broader context, including the participant’s background, transaction history, and any other pertinent information.

Anomalies in trade settlement processes

Another common scenario that may necessitate a SAR is anomalies in trade settlement processes. Delays in settlement, repeated failed trades, or discrepancies in the information provided by trading parties may indicate an attempt to cover up illicit activities or the involvement in fraudulent schemes. For instance, a pattern of trades being executed at prices significantly different from the prevailing market rates might suggest price manipulation or insider trading. In such cases, filing a SAR would not only fulfill regulatory obligations but also help in alerting authorities to potential financial crimes, thereby contributing to the overall integrity and transparency of the financial markets.

Recognizing AML red flags is crucial for effective monitoring. Some key indicators include:

• Large transactions or sudden changes in spending habits
• Structuring: breaking large sums into smaller deposits
• Rapid movement of funds between accounts
• Transactions with high-risk countries
• Use of anonymous entities or shell companies
• Unexplained wealth increases
• Discrepancies between shipped goods and declared values

Financial institutions should closely scrutinize these red flags and investigate any suspicious activity thoroughly.

Filing Suspicious Activity Reports (SARs)

When suspicious activities are detected, financial institutions are required to file Suspicious Activity Reports (SARs) with FinCEN. SARs must be filed within 30 calendar days of initial detection of suspicious activity. If no suspect is identified, institutions may delay filing for an additional 30 days, but no more than 60 days after initial detection. It’s crucial to maintain proper documentation and retain copies of filings for five years. When filing SARs, institutions should provide detailed descriptions of the suspicious activity and select all applicable characterization boxes.

Additional Resources

How To Launch Your Alternative Trading System (ATS): Insights and challenges when launching an ATS

Unmask the Risks: Protect Your Firm with a Strong AML Program

Having an AML Program Isn’t Enough

To wrap up, the fight against money laundering is an ongoing challenge that requires constant vigilance and adaptation. The establishment of a strong Anti-Money Laundering program has a significant impact on alternative trading systems’ ability to combat financial crime effectively. By conducting thorough risk assessments, building a skilled team, and fostering a compliance-focused culture, alternative trading systems can better protect themselves and the financial system as a whole.

Ensuring Compliance and Reducing Financial Crime Risks

Oyster’s regulatory compliance consultants have a deep understanding of AML and compliance program requirements for broker-dealers and alternative trading systems. Oyster’s experts have been CCOs, Compliance Officers and consultants for wealth management firms of all shapes and sizes. We have also developed, implemented, tested and remediated AML programs.