This bulletin[1] highlights for broker-dealers various risks arising from illicit activities associated with transactions in low-priced securities[2] through omnibus accounts, particularly transactions effected on behalf of omnibus accounts[3] maintained for foreign financial institutions.[4] These risks are heightened when the identities of a foreign financial institution’s underlying customer and/or the ultimate beneficial owner[5] of the funds and securities are unknown to a broker-dealer because of the omnibus account structure.[6]

This bulletin also reminds broker-dealers of their existing obligations under the Bank Secrecy Act (“BSA”),[7] Rule 17a-8 under the Exchange Act, Section 5 of the Securities Act of 1933 (“Securities Act”) and FINRA rules, and considerations relating to the application of these obligations in the context of effecting low-priced securities transactions through omnibus accounts maintained for foreign financial institutions. In the Staff’s view, sufficiently discharging existing anti-money laundering (“AML”) obligations under the BSA requires broker-dealers to consider, among other things, the risks associated with the multiple layers of accounts through which transactions in these types of securities may have been routed.[8] Specifically, in order to sufficiently manage the heightened risks that can be associated with low-priced securities transactions effected through omnibus accounts maintained for foreign financial institutions, a broker-dealer should consider whether it is appropriate to obtain information regarding the relevant characteristics of ultimate beneficial owners of the funds and securities (e.g., the registration status of the ultimate beneficial owner, or whether it is an entity or an individual), including their identities when the risk warrants such inquiry.[9] Where the broker-dealer determines that the risks posed cannot be appropriately managed through the results of such inquiries or other risk mitigation measures, the Staff believes that broker-dealers should consider (1) refusing to open or closing the omnibus account, (2) restricting or rejecting transactions in low-priced securities effected on behalf of the customers of the foreign financial institution through such accounts, and (3) filing a Suspicious Activity Report (“SAR”) as appropriate.[10]

Key Takeaways:

• Low-priced securities transactions in omnibus accounts maintained for foreign financial institutions can pose a particularly high risk of illicit activities, including fraud, money laundering, and unregistered securities offerings.
• Nominee accounts and multiple foreign financial intermediaries can be used to obscure the identities of persons engaging in illicit activities.
• Layers of anonymity and concealment can facilitate violations of the federal securities laws, such as non-exempt unregistered securities offerings, fraudulent stock promotion and manipulative trading, as well as other illicit activities.
• Specific AML due diligence and reporting obligations apply to omnibus relationships with foreign financial institutions regardless of whether the ultimate beneficial owner of the funds and securities held in the account is a broker-dealer’s “customer” for customer identification programs (“CIP”) and CDD purposes or a “beneficial owner” for CDD purposes.[11] For example, a broker-dealer must file a SAR on a suspicious transaction, whether or not the ultimate beneficial owner who requested the transaction is considered the broker-dealer’s customer.
• A broker-dealer’s inability to obtain information regarding the ultimate beneficial owners of funds and securities held in an omnibus account engaging in transactions that are considered higher risk (such as low-priced securities transactions) significantly increases the AML and other legal and compliance risks of the foreign omnibus account associated with those transactions.

1. What Has the Staff Been Seeing?

In the past few years, the Commission has brought a number of enforcement actions centered on allegations of unregistered securities offerings and/or schemes to defraud investors that have involved individuals and entities that allegedly concealed their control of publicly traded companies and increasingly used omnibus accounts to purchase and/or liquidate low-priced securities.[12] These scenarios often involve allegations that omnibus accounts opened at a U.S. broker-dealer by a foreign financial institution can act to shield the nature of the illicit activities by, among other things, concealing a wrongdoer’s identity. These charges collectively also involve allegations of hundreds of millions of dollars in illegal sales proceeds at the expense of U.S. retail investors. These proceeds often were quickly transferred to overseas accounts.

To illustrate the chain of events that may be associated with scenarios involving low-priced securities transactions through omnibus accounts maintained for foreign financial institutions, the Staff has outlined below a typical fact pattern. This fact pattern can vary and include various combinations of the following components and other actions:

• Obtain Controlling Interest in an Issuer: First, an individual or a group of individuals (“Control Group”)[13] obtains a controlling interest in an issuer by, for example, acquiring a large quantity of low-priced securities of the issuer that do not include a restrictive legend.
• Transfer to Nominees: The Control Group typically has the low-priced securities transferred to nominees, which are commonly offshore entities with foreign owners, with no apparent purpose other than to conceal the existence of and the identity of the Control Group, who maintains control of the securities. In an effort to evade detection and identification, such as through required disclosure of the existence of the Control Group, each nominee generally holds account-level positions of less than 5% of the total issued and outstanding securities.[14]
• Accounts are Layered through “Nested” Account Relationships: The Control Group often opens several accounts on behalf of the nominees with a series of foreign intermediaries, which in turn deposit and subsequently trade through a series of other foreign intermediaries.
  • Foreign intermediaries frequently use omnibus accounts in their names at other foreign intermediaries to execute the trades as instructed by the Control Group. All trading is ultimately controlled by and for the benefit of the Control Group, who communicates only with certain foreign intermediaries.
  • There may be several layers of foreign intermediaries handling the order flow through successive omnibus account relationships before the trades are consolidated and ultimately executed with a U.S. broker-dealer.
• Foreign Financial Institutions Execute Trades at U.S. Broker Dealer(s): The foreign intermediaries execute trades through their omnibus accounts (which may be Delivery versus Payment/Receipt versus Payment (“DVP/RVP”) accounts) at U.S. broker-dealer(s).[15] To attempt to evade scrutiny and reduce the likelihood of raising red flags of potential suspicious activity, the Control Group may use a network of foreign financial institutions and U.S. broker-dealers to transact in the low-priced securities so that none of them has complete visibility into the total amount of securities deposited, trading volume and activity, timing of the wire transfers of sales proceeds and other information.

By spreading the securities and trading activity among nominee accounts at multiple foreign intermediaries through multiple omnibus accounts, the Control Group obfuscates the identities of the ultimate beneficial owners of the funds and securities held in the accounts.

The layers of concealment enable the Control Group to engage in a fraudulent scheme (e.g., a fraudulent promotion of the stock, pump and dump, or coordinated manipulative trading), an unregistered distribution of securities, unregistered broker-dealer activity, and/or insider trading.

2. What Contributes to the Illicit Activity?

This type of illicit activity is facilitated when information about the identities of the individuals who buy and/or sell low-priced securities is shielded by the omnibus account structure.[16] In the scenario discussed above, a U.S. broker-dealer typically knows only the identity of the foreign financial institution, and not the identity or relevant characteristics of the ultimate beneficial owner of the funds and securities associated with the illicit activity.

The Staff is concerned that this type of illicit activity, including fraud or unlawful distributions of securities, is being facilitated by U.S. broker-dealers who are not sufficiently discharging their AML and other obligations. In particular, the Staff is concerned that certain broker-dealers may be conducting insufficient due diligence on omnibus accounts held for foreign financial institutions, including insufficiently accounting for the risks associated with the nature of the foreign financial institution’s business and the markets it serves (including whether it offers services to other financial institutions and their customers) and the type, purpose, and anticipated activity of such omnibus accounts.

The Staff is also concerned that some U.S. broker-dealers may ignore red flags[17] associated with the illicit activity and fail to report known or suspected suspicious activity conducted through the accounts. Moreover, to the extent a U.S. broker-dealer’s due diligence and risk assessment of a foreign omnibus account is dependent upon the activities of another financial institution, including an affiliate, that reliance may be unreasonable.[18] For example, the other financial institution may not recognize the various risks associated with transactions in these types of securities; may be lax in its due diligence or assign ineffective risk weighting to transactions in these types of securities; or may be unfamiliar with or otherwise ignore common fact patterns of manipulation, concealment of coordinated activity and other illicit activities, including the increased risk of those activities associated with transactions involving low-priced securities.

3. What are the Staff’s Views Regarding a U.S. Broker-Dealer’s AML Obligations when Engaging in Transactions in Low-Priced Securities through Omnibus Accounts Maintained for Foreign Financial Institutions?

There are three key AML obligations that broker-dealers should consider when engaging in transactions in low-priced securities effected through omnibus accounts, particularly transactions effected on behalf of omnibus accounts maintained for foreign financial institutions: (1) AML program requirements; (2) correspondent account due diligence requirements; and (3) suspicious activity reporting obligations. Below is an overview of these obligations and the Staff’s views.[19]

Overview of AML Obligations

Among other things, the BSA requires broker-dealers to establish a risk-based AML program, including policies and procedures reasonably designed to detect and report suspicious activities (“AML Program”).[20] Specifically, a broker-dealer’s AML Program must be in writing and, among other things:

• Establish and implement policies, procedures, and internal controls reasonably designed to achieve compliance with the applicable provisions of the BSA and implementing regulations thereunder;[21]
• Establish and implement policies and procedures that can be reasonably expected to detect and cause the reporting of transactions required under the BSA;[22] and
• Include appropriate risk-based procedures for conducting ongoing customer due diligence, to include, but not be limited to, the following:
  • Understanding the nature and purpose of customer relationships to be able to develop a customer risk profile; and
  • Conducting ongoing monitoring to identify and report suspicious transactions as well as, on a risk basis, to maintain and update customer information, including beneficial ownership information for legal entity customers.[23]

In addition, as part of their AML Program, broker-dealers are required to establish a written risk-based due diligence program for any “correspondent accounts”[24] established, maintained, administered or managed for foreign financial institutions (“Special Due Diligence Program”), which include omnibus accounts held for a foreign financial institution introducing transactions in low-priced securities.[25]

Specifically, the Special Due Diligence Program must include appropriate, specific risk-based policies, procedures, and controls reasonably designed to enable a broker-dealer to detect and report, on an ongoing basis, any known or suspected money laundering conducted through or involving any foreign correspondent account.[26] At a minimum, the due diligence program must include, among other things, the following:

• An assessment of the money laundering risk posed by such correspondent account, based on a consideration of relevant risk factors, including, as appropriate:
  1. The nature of the foreign financial institution’s business and the markets it serves;
  2. The type, purpose, and anticipated activity of such correspondent account;
  3. The nature and duration of the broker-dealer’s relationship with the foreign financial institution (and any of its affiliates);
  4. The AML and supervisory regime of the jurisdiction that issued the charter or license to the foreign financial institution, and its owners if applicable, to the extent that such information is reasonably available;
  5. Information known or reasonably available to the broker-dealer about the foreign financial institution’s AML record; and
• The application of risk-based procedures and controls to each such correspondent account reasonably designed to detect and report known or suspected money laundering activity, including a periodic review of the correspondent account activity sufficient to determine consistency with information obtained about the type, purpose, and anticipated activity of the account.[27]

The five enumerated factors must be considered with regard to each correspondent account, as relevant, although it is not expected that it will be necessary to apply each factor to every correspondent account relationship.[28] Although in some cases application of all five factors may be appropriate, a broker-dealer may apply some subset of the factors, depending upon the broker-dealer’s determination of the nature of the foreign financial institution that it is assessing and the relative money laundering risk posed by the institution.[29] Similarly, the five factors are not meant to be exhaustive, and broker-dealers are expected to consider additional factors that are relevant to the particular risk profile of the foreign financial institution being assessed.[30] As a result, a broker-dealer’s due diligence program should provide, as appropriate, for the consideration of additional factors that have not been enumerated in the rule when assessing foreign financial institutions with a unique risk profile or those that pose high risk.[31]

FinCEN has made clear to broker-dealers that the Special Due Diligence Program supplements rather than supersedes a broker-dealer’s AML Program and that in high-risk situations involving any account, an AML Program should include provisions for obtaining any necessary and appropriate information about the customers underlying such an account.[32]

Finally, under FinCEN’s SAR rule, broker-dealers are required to file a SAR if: (1) a transaction is conducted or attempted to be conducted by, at, or through a broker-dealer; (2) the transaction involves or aggregates funds or other assets of at least $5,000; and (3) the broker-dealer knows, suspects, or has reason to suspect that the transaction –

(a) involves funds or is intended or conducted in order to hide or disguise funds or assets derived from illegal activity as part of a plan to violate or evade any Federal law or regulation or to avoid any transaction reporting requirement under Federal law or regulation;

(b) is designed to evade requirements of the BSA;

(c) has no business or apparent lawful purpose or is not the sort in which the particular customer would normally be expected to engage, and the broker-dealer knows of no reasonable explanation for the transaction after examining the available facts; or

(d) involves the use of the broker-dealer to facilitate criminal activity.[33]

Staff Views Regarding Application of AML Obligations to Foreign Omnibus Accounts

The Staff believes that foreign financial institutions engaging in low-priced securities transactions on behalf of their customers through an omnibus account structure present a particularly high risk for illicit activities, including money laundering. Broker-dealers servicing these accounts are reminded that, pursuant to the Special Due Diligence Program requirements, they must assess the money laundering risks posed by their relationship with the foreign financial institution based on a consideration of the risk factors described above.

In the context of low-priced securities transactions, the Staff believes that relevant risk factors that a broker-dealer is expected to consider include, without limitation, the spectrum of activities involved and the foreign financial institution’s demonstrated ability and commitment to addressing the AML, securities law and other risks associated with those activities, in addition to the five other factors enumerated. Furthermore, in the Staff’s view, a consideration of these factors in this context – particularly the nature of the foreign financial institution’s business and the markets it serves (including whether it offers services to other financial institutions and their customers, which are sometimes referred to as nested relationships) and the type, purpose, and anticipated activity of such an omnibus account – generally should include an assessment of the risks imputed to the foreign financial institution by its underlying customers.[34] With respect to transactions that involve heightened risk, the Staff believes that this should include an assessment of underlying customers at a more granular (or even individual) level.

With respect to the typical fact pattern described in section 1 of this bulletin, broker-dealers should consider, among other things, the risks associated with any nested account relationships, where its foreign financial institution customer may be requesting a transaction on behalf of one of a series of other financial institutions, one of which has the direct customer relationship with the ultimate beneficial owner. Broker-dealers should recognize that each such institution may be subject to varying degrees of regulatory obligations and oversight. As a result, customer risk assessment policies and procedures at one institution that may be sufficient if the customer is the ultimate beneficial owner may be insufficient if the customer is another financial institution acting on behalf of the ultimate beneficial owner. Accordingly, a broker-dealer’s Special Due Diligence Program should take into account whether or not the account relationship is a nested account relationship and if so, the number of layers involved. The Staff believes that varying (and increasing) levels of risk may be presented in such circumstances, and accordingly different (and increasing) levels and types of risk assessment measures and risk-based procedures and controls may be necessary. For example, a customer relationship in which the foreign financial institution customer is acting directly on behalf of the ultimate beneficial owner generally would present a different risk and require different risk-based procedures and controls than a relationship in which the foreign financial institution is acting on behalf of the ultimate beneficial owner through one or more other financial institutions. Each of these relationships present a different level of risk and requires a different level of risk assessment and risk-based procedures and controls.

In many instances, it may be difficult or impossible to obtain information about a foreign financial institution’s underlying customers, and in particular, ultimate beneficial ownership information for the funds and securities associated with an account. For example, privacy restrictions may prevent a broker-dealer from obtaining information about the foreign financial institution’s underlying customer that the broker-dealer would otherwise have considered. The Staff does not believe that these or other information access restrictions lessen the broker-dealer’s AML and other obligations. Rather, the Staff believes that these types of restrictions on beneficial ownership and other customer information generally increase the risk associated with an account, which should be taken into account in policies and procedures that the broker-dealer implements to discharge its AML and other obligations. We are aware that alternative or compensatory steps currently employed may include, among others, (1) obtaining a certification from the foreign financial institution that it has verified the identity of its customer[35] and/or the ultimate beneficial owner and that it provides the information necessary (on an anonymized basis) to assess whether the transactions are suspicious; (2) engaging in more robust monitoring of transactions introduced by the foreign financial institution; and/or (3) adjusting alert parameters. There are circumstances where these alternative or compensatory steps would be insufficient to mitigate the risks of transacting in low-priced securities.

Where the broker-dealer determines that the risks cannot be appropriately managed, particularly in the context of low-priced securities transactions, the Staff believes that a broker-dealer should consider (1) refusing to open or closing the account, (2) restricting or rejecting transactions effected on behalf of the customers of the foreign financial institution (e.g., restricting transactions to those effected on behalf of ultimate beneficial owners where the relevant characteristics of those owners are known by the foreign financial institution and communicated to the U.S. broker-dealer to a sufficient extent for the U.S. broker-dealer to conclude that there is not a heightened risk of illicit activity), and (3) filing a SAR as appropriate.

Broker-dealers are reminded that nothing under the federal securities laws or FINRA rules obligates them to accept an order where they believe that the associated compliance or legal risks are unacceptable. In light of this fact, broker-dealers should consider the consequences of facilitating transactions, regardless of whether or not they fulfill their AML obligations. For example, under certain circumstances, a broker-dealer may fulfill its AML obligations by detecting and reporting suspicious activity, but in facilitating the transactions, the broker-dealer could expose itself to liability for aiding and abetting and/or causing misconduct, including by participating in an unregistered securities offering.

Intersection with CIP and CDD Obligations. As part of their AML obligations, broker-dealers also have an obligation to establish a written CIP to verify the identities of customers seeking to open an account.[36] In addition to the CIP obligation, broker-dealers are subject to CDD requirements to identify and verify the identity of beneficial owners of their legal entity customers pursuant to FinCEN’s CDD rule.[37]

The Staff notes that, in many circumstances associated with omnibus account relationships, the broker-dealer’s “customer,” for purposes of the CIP and CDD rules, would be the foreign financial institution and not the financial institution’s underlying customer and/or the ultimate beneficial owner of the low-priced security.[38] However, it is critical for broker-dealers to remember that even when the ultimate beneficial owner is not a broker-dealer’s “customer” for CIP and CDD purposes, there are circumstances where the characteristics of that ultimate beneficial owner would need to be considered as part of the broker-dealer’s broader AML obligations.[39] As stated above, in high-risk situations, information about the underlying customers and/or the ultimate beneficial owners (whether broadly understood as the types of customers with whom the foreign financial institution typically conducts business or in more granular terms where the circumstances and related risks of the account or particular transactions require such information), would be relevant to a broker-dealer’s assessment of the money laundering risks posed by the foreign financial institution itself as part of its broader AML Program and Special Due Diligence Program.

Moreover, while the CDD rule does not require broker-dealers to collect information that identifies the underlying transacting parties (i.e., a customer’s customer) in an omnibus account, broker-dealers may determine that a foreign financial institution presents a higher risk profile and, accordingly, collect additional information to better understand the customer relationship.[40] In this vein, broker-dealers are reminded that the CDD rule requirements represent a “floor” in that it establishes a minimum course of action and, consistent with a risk-based approach pursuant to their broader AML program requirements, they may need to do more in situations of heightened risks.[41]

4. Other Risks and Related Broker-Dealer Obligations

Broker-dealers are also reminded of their obligations: (1) to conduct a reasonable inquiry when selling securities in an unregistered transaction in reliance on Section 4(a)(4) of the Securities Act, and (2) pursuant to sanctions imposed by OFAC.[42]

Reasonable Inquiry. With respect to transactions in securities, Section 5 of the Securities Act requires all offers and sales of securities in interstate commerce to be registered unless an exemption from registration is available. Section 4(a)(4) of the Securities Act provides such an exemption for “brokers’ transactions executed upon customers’ orders on any exchange or in the over-the-counter market but not the solicitation of such orders.” The Commission has stated, in connection with the Section 4(a)(4) exemption, that broker-dealers “‘have a responsibility to be aware of the requirements necessary to establish an exemption from the registration requirements of the Securities Act and should be reasonably certain such an exemption is available.’”[43] Broker-dealers “must conduct a reasonable inquiry into the circumstances surrounding the transaction before the [broker-dealers] may claim the protection of the Section 4(a)(4) broker’s exemption.”[44] A broker-dealer may claim the Section 4(a)(4) exemption if it “[a]fter reasonable inquiry is not aware of circumstances indicating that the person for whose account the securities are sold is an underwriter with respect to the securities or that the transaction is part of a distribution of securities of the issuer.”[45]

In light of the risks of illicit activities associated with transactions in low-priced securities through omnibus accounts maintained for foreign financial institutions as discussed in this bulletin, broker-dealers should consider, as part of their reasonable inquiry, whether it is appropriate to obtain information regarding the foreign financial institutions’ underlying customers and the ultimate beneficial owners of the funds and securities, and whether such information is available. In situations where a broker-dealer determines it is appropriate to obtain such information but cannot, whether because of privacy restrictions or otherwise, the broker-dealer should consider the absence of this information as part of its assessment of whether it is reasonable to proceed with the transaction.

OFAC. OFAC administers and enforces economic and trade sanctions programs that are separate and distinct from, and in addition to, the AML requirements imposed on broker-dealers under the BSA.[46] In general, OFAC regulations require broker-dealers to: block accounts and other property or property interests of entities and individuals that appear on OFAC’s List of Specially Designated Nationals and Blocked Persons or entities that are blocked by operation of law, including entities blocked because they are owned, individually or in the aggregate, directly or indirectly, 50 percent or more by one or blocked persons; block accounts and other property or property interests of governments, other entities, and individuals subject to blocking under OFAC country-based programs; and reject prohibited, unlicensed trade and financial transactions, including those involving OFAC-sanctioned countries. Broker-dealers must report to OFAC all blockings and rejections of prohibited transactions within 10 days of their being identified, and blocked property must be reported to OFAC annually.[47] In addition to the blocking sanctions described above, OFAC maintains several sanctions programs that prohibit U.S. persons, including broker-dealers, from dealings in equity and debt of, and extension of credit to, certain sanctions targets. OFAC has stated that it will take into account the adequacy of a firm’s OFAC compliance program, among other factors, when it determines the appropriate enforcement response to an apparent violation, including whether a civil monetary penalty is warranted.[48]

5. Summary

As highlighted above, the Staff is concerned about illicit activities involving low-priced securities transactions executed through omnibus accounts held in the name of foreign financial institutions. Broker-dealers should be aware of the common fact patterns and red flags associated with these transactions and appropriately account for the heightened risks of illicit activities. The Staff reminds broker-dealers of their existing risk-based AML obligations under the BSA, Exchange Act Rule 17a-8, and FINRA rules, as well as their obligations to address compliance with other legal requirements, such as Section 5 of the Securities Act and OFAC regulations. In addition to establishing risk-based AML compliance programs, broker-dealers should understand that sufficiently discharging existing AML obligations under the BSA may require, among other things, accounting for the risks associated with the multiple layers of accounts through which transactions may have been routed. Specifically, the Staff believes that in order to sufficiently manage the heightened risks associated with low-priced securities transactions effected through foreign omnibus accounts, a broker-dealer generally should inquire about the ultimate beneficial owners of the funds and securities under appropriate, risk-based circumstances.[49]

Key Red Flags from FINRA Regulatory Notice 19-18:

• An account is opened in the name of a foreign financial institution, such as an offshore bank or broker-dealer, that sells shares of stock on an unregistered basis on behalf of customers.
• An account is opened for a foreign financial institution that is affiliated with a U.S. broker-dealer, bypassing its U.S. affiliate, for no apparent business purpose. An apparent business purpose could include access to products or services the U.S. affiliate does not provide.
• The account is using a master/sub structure, which enables trading anonymity with respect to the sub-accounts’ activity, and engages in trading activity that raises red flags, such as the liquidation of microcap issuers or potentially manipulative trading activity.
• There is a sudden spike in investor demand for, coupled with a rising price in, a thinly traded or low-priced security.
• The customer’s activity represents a significant proportion of the daily trading volume in a thinly traded or low-priced security.
• The customer is domiciled in, doing business in or regularly transacting with counterparties in a jurisdiction that is known as a bank secrecy haven, tax shelter, high-risk geographic location (e.g., known as a narcotics producing jurisdiction, known to have ineffective AML/Combating the Financing of Terrorism systems), or conflict zone, including those with an established threat of terrorism.
• The customer, for no apparent reason or in conjunction with other “red flags,” engages in transactions involving certain types of securities, such as penny stocks, Regulation “S” stocks and bearer bonds, which although legitimate, have been used in connection with fraudulent schemes and money laundering activity. (Such transactions may warrant further due diligence to ensure the legitimacy of the customer’s activity.)
• A customer buys and sells securities with no discernable purpose or circumstances that appear unusual.
• Two or more unrelated customer accounts at the firm trade an illiquid or low-priced security suddenly and simultaneously.
• The customer appears to buy or sell securities based on advanced knowledge of pending customer orders.