Leading multinational banks and the U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) are failing to stop billions of dollars in money laundering, according to an investigative report dubbed the “FinCEN Files” – from Buzzfeed News and the International Consortium of Investigative Journalists.
The findings are shocking, but not surprising to the regulatory experts and regulatory technology (regtech) startups working to prevent money laundering. The scandal sets the stage for why U.S. regulators are bullish on regtechs.
“This was 100% confirmation of what people already knew,” said Adam Shapiro, a former U.K. regulator and partner at Klaros Group, a regulatory and business consultancy.
U.S. and Canadian financial institutions spend over $30 billion annually on anti money laundering (AML) compliance costs, but less than 1% of laundered funds are caught, estimated the United Nations in 2011.
The industry experts FinLedger spoke to all agree the system needs tinkering, if not an outright overhaul, and that better regulatory technology will be essential for affecting substantive change.
Beefing up SARs
Suspicious Activity Reports (SARs) are the primary legal mechanism by which U.S.-based financial institutions report suspicious financial activity to FinCEN. Over 2 million SARs were filed last year, “the vast majority of which are shelved or overlooked,” according to Buzzfeed’s report. Addressing the insufficiency of SARs is at the top of reformers’ bucket list.
“Think of SARs as a communication channel between industry and law enforcement,” said Joe Robinson, CEO and co-founder of Hummingbird, a Los Angeles-based regtech that automates SARs filing and provides a platform for managing compliance teams. “There can be improvements to the ways that communication happens, making it more real-time and collaborative.”
Meredith Moss, founder and CEO of Finomial, a Boston-based regtech focused on improving Know Your Customer (KYC) procedures, agrees.
“Regulators need to take a stronger stance in expecting banks to have technology which automates client diligence and can flag exceptions, rather than filing SARs and dumping the ex post facto responsibility on the regulators,” she told FinLedger. “It is essential to focus on client onboarding and monitoring to eliminate money launderers before they start using banking systems for illegal transactions.”
Regtechs can also make individual SARs more robust, which is among the things that ComplyAdvantage, a London-headquartered regtech, is seeking to achieve. “Thick-file SARs” should be “the standard,” according to CEO and founder Charles Delingpole, who believes that SARs should include “extensive information on transactions, recipients, behavior, frequency, the ultimate beneficial owners of related companies, and other companies those people own.”
Most regtechs use (or are seeking to use) artificial intelligence (AI) and machine learning (ML) in their products. For compliance staff sifting through reams of customer data, AI and ML can save time and free up humans to do higher level analysis.
“AI is going to be huge in this area,” said Shapiro of Klaros. “But we need to walk before we can run.”
AI brings potential second-order effects that must also be considered. For example, Robinson of Hummingbird expressed concern that AI risks “introducing systemic bias into the system,” which echoes worries in other contexts about AI discriminating against women and people of color.
Increasing industry collaboration
Introducing new technology is only part of the AML equation. Some experts say that technology must contribute to information sharing among financial institutions and between companies and government agencies.
Public-private partnerships – arrangements where compliance staff work directly with regulators to walk through suspicious activity and patterns – are one option, said Rick McDonell, executive director of the Association of Certified Anti-Money Laundering Specialists (ACAMS). This model has been effective in Australia, the United Kingdom, and other countries, according to McDonell.
Shapiro believes a more comprehensive solution is needed. He calls for the creation of a “centralized, industry-funded utility,” in which financial institutions pool transaction information and associated tax IDs onto a single data platform, from which FinCEN can pull information to help their investigations.
Robinson agrees that more industry collaboration is needed, but cautions against potential side-effects.
“The only people better than venture capitalists at finding early-stage fintechs are criminals.”
Learn more about why U.S. regulators are bullish on regtechs in this Q&A with Hummingbird CEO Joe Robinson. Read more here.
“What you would not want is some sort of block list being developed, where one financial institution inhibits another financial institution from participating in a transaction,” he told FinLedger. “We don’t want financial institutions becoming lawmakers.”
Absent more private-public teamwork, FinCEN and other government agencies may also benefit from working directly with regtechs.
“I do think there is a role for regtechs to be contracted by regulatory agencies,” said Megan Prendergast Millard, a former New York state regulator and Senior Managing Director at Guidepost Solutions, a compliance and security firm. “There will always be a need for review by skilled law enforcement investigators and regulators but regtechs can assist in the initial review of filings to allow the investigators to spend more time developing and working on critical cases.”
What’s more, U.S. regulators are “bullish on regtechs,” Millard said. “The New York Department of Financial Services created a Research and Innovation Division in 2019, the Federal Reserve is offering innovation office hours at the regional banks and it is open to regulated institutions as well as non-bank fintechs, and the OCC has a dedicated Office of Innovation.”
She added that regtechs that can provide and demonstrate audit trails and capabilities “will be the most appealing to the regulators as they integrate within financial institutions.”
Uncertainty about what’s next
There is mixed opinion about whether the FinCEN Files will spur new legislative or regulatory action in the United States.
McDonell of ACAMS notes that revelations of money laundering at Denmark-based Danske Bank spurred the European Commission to propose new AML rules.
“Major scandals often result in tougher laws and compliance, and that’s a good thing,” he said.
A few days before Buzzfeed published its investigation, the Treasury Department rolled out an advance notice of proposed rule-making (ANPR) on financial institutions’ anti-money-laundering program, but some doubt that measure has any teeth.
“An ANPR is not a regulation or even a proposed one, its purpose is for regulators and government agencies to solicit comments from the public on a wide range of questions,” said Mayra Rodriguez Valladares of MRV Associates, a regulatory consultancy. “Until financial institutions are fined a lot more, closed down, and those who look away are hauled off in handcuffs, no ANPR or even bad headlines will do much.”