Amicus Briefs Urge that Only FinCEN, Not the SEC, Should Enforce the BSA in Regards to Broker-Dealers

In the next stage of the Alpine Securities saga (as we blogged about here, here and here), a petition for a writ of certiorari is pending before the Supreme Court, asking the Court to decide whether the Southern District of New York and the Second Circuit correctly decided that the Securities Exchange Commission (“SEC”) may bring suit directly to enforce compliance with the Bank Secrecy Act (“BSA”).  Distilled, the Second Circuit and the District Court ruled that by promulgating Rule 17a-8, which states in part that “[e]very registered broker or dealer who is subject to the requirements of the [BSA] shall comply with the reporting, recordkeeping and record retention requirements of [BSA regulations promulgated by FinCEN],” the SEC is properly exercising its own independent authority under Rule 17a-8 and Section 17(a) of the Exchange Act when it regulates broker-dealers for the record-keeping and reporting requirements of the BSA.

Alpine Securities’ petition (the “Petition”) has received support in the form of amicus briefs from former officials of the Financial Crimes Enforcement Network (“FinCEN”) and the Cato Institute (“CATO”), both of which argue the SEC does not have the power to enforce violations of the BSA.  As we will discuss, the amicus briefs argue that only FinCEN may enforce the BSA, and that a contrary system would undermine FinCEN and create unacceptably conflicting interpretations, standards, and penalties for BSA/anti-money laundering (“AML”) compliance.

The “FinCEN” Brief

Former FinCEN director James H. Freis, Jr. and former deputy director Charles M. Steele filed their amicus brief on August 20, 2021. Freis and Steele hold themselves out as having

extensive expertise with and insights into FinCEN’s operations; its unique placement at the intersection of financial institutions, their supervisory authorities, and law enforcement and national security agencies; and the carefully crafted AML and countering the financing of terrorism regime enacted by Congress in the Bank Secrecy Act (BSA).

Freis and Steele state that they are concerned “that the Second Circuit’s misunderstanding of FinCEN’s delegated enforcement authority will lead to confusion among the financial institutions that must comply with the BSA; create multiple, conflicting BSA regulatory regimes; decrease American influence over global financial regulators; and hamper U.S. law enforcement and national security efforts by diminishing the value of BSA data.”

In essence, Freis and Steele’s amicus brief attacks the Second Circuit decision as ignoring three key points: 1) Congress granted BSA enforcement authority to the Treasury Department, which delegated that authority to the Director and FinCEN, and therefore only Congress can contravene that stated purpose; 2) FinCEN, pursuant to its delegated authority, plays an integral law enforcement role and offers unique value due to its ability to bridge the gap between the public and private sector; and 3) allowing other regulators to enforce the BSA will lead to conflicting interpretations, standards, and penalties, and will undermine FinCEN on the global AML stage.

The Role of FinCEN

Freis and Steele point to the BSA’s express language which permits the Treasury Secretary to establish minimum standards for AML programs, enforce compliance with the BSA and related regulations through civil penalties, and delegate duties and powers under the BSA to an appropriate supervising agency.  The Treasury Secretary did so with the Director of FinCEN, delegating “overall authority for enforcement and compliance, including coordination and direction of procedures and activities of all other agencies exercising delegated authority.”

Freis and Steele observe that FinCEN is too small to adequately monitor and examine all of the various entities its regulations cover, and that the Treasury Department therefore delegated authority to other “specialized regulators to examine entities for BSA compliance, typically as part of a broader regulatory examination within the agency’s purview” to address this shortfall.  Freis and Steele then argue – perhaps in tension with their acknowledgement that FinCEN is strapped for resources – that the Treasury Department has never delegated enforcement authority to any other agency, and that it must be FinCEN alone that performs enforcement under the BSA.

Freis and Steele seek to emphasize FinCEN’s unique role in BSA/AML compliance.  They explain that Congress enacted and expanded the BSA to include requirements for filing Suspicious Transaction Reports (“SARs”) used by law enforcement for investigative leads, and argue that FinCEN’s utility is inevitably tied to the fact that it is the agency that receives all SARs filed by every financial institution covered by the BSA.  As such, FinCEN’s relationship with the private sector facilitates this “free-flow of information.”  FinCEN’s provision of support to other regulators that examine financial institutions under the BSA, as well as its information-sharing agreements with state and federal partners, puts it at the forefront of BSA interpretation, guidance, and enforcement.  FinCEN also serves as “an influential advocate for effective international standards,” and “works with foreign financial crime investigatory agencies to help stop crime.”

However, Freis and Steele do not articulate clearly why it is acceptable to have multiple agencies performing BSA examinations – thereby making potentially different value judgments and negative exam findings regarding examined institutions’ SAR filings (or lack thereof) – but it is not acceptable to have any agency other than FinCEN seek to enforce the negative exam findings of a given agency.  Stated otherwise, the current system of bifurcated examination and enforcement (for example, the IRS examines casinos for BSA/AML but must look to FinCEN for related non-criminal enforcement) already involves different agencies making potentially different interpretations of when SARs should be filed or how other BSA duties should be fulfilled.  Indeed, and as Freis and Steele later note, FinCEN itself cannot directly enforce anything if it is contested, and instead must turn to the Department of Justice to do so.  And of course, the federal banking regulators, such as the Office of the Comptroller of the Currency, both examine for and enforce alleged violations of the BSA.

The Second Circuit Got it Wrong?

Freis and Steele attack the Second Circuit’s decision on several fronts.

First, they argue that the Court conflated the concepts of examination and enforcement.  On the one hand, FinCEN has delegated authority to examine financial institutions for BSA compliance, but that power is distinct from the enforcement power, which is reserved to the Secretary of the Treasury by the BSA, and the Secretary delegated that authority to the Director of FinCEN’s. The SEC has been delegated only the power to examine, not to enforce.  In the instant appeal, Freis and Steele point out that the success of the SEC’s enforcement action “depends on showing a violation of FinCEN’s regulations,” and therefore the SEC is acting outside the scope of its authority by enforcing the BSA.  Freis and Steele argue that should this outcome stand, it “will result in different standards, confusion, increased risk-aversion and over-compliance, and degradation of the value of BSA data, especially SARs.”

Freis and Steele then emphasize that the SEC can choose to pursue enforcement through its favorable ALJ process, whereas FinCEN may only pursue litigation subject to the processes and protections of federal district court.  They note that the SEC “can subject financial institutions to an entirely different adjudicatory framework,” which can lead to different and confusing precedent, and potentially harsher penalties.  As further illustration, in this case the SEC “applied a lower scienter requirement, imposed harsher civil monetary penalties, and took an inflexible and harmful position as to what constitutes an actionable SAR violation.”  And generally, the SEC can seek large monetary penalties and severe administrative sanctions against SAR violators in its own administrative proceedings.  The SEC’s available procedures, they add, “delays judicial review of contested cases and gives the Commission significant leverage over regulated entities.”  By emphasizing the administrative process utilized by the SEC, Freis and Steele implicitly are referring to certain long-standing critiques that the SEC ALJ system is biased in favor of the SEC.

FinCEN, on the other hand, can only impose civil monetary penalties and does not have any ALJs to conduct evidentiary hearings.  Rather, FinCEN can only pursue injunctions in federal district court while being represented by the Department of Justice.  Distilled, Freis and Steele are arguing that it is unfair to accept a system in which the SEC can increase its chances of winning, and presumably win more often than FinCEN, by choosing the forum in which it litigates.

The risk for conflicting procedures, interpretations, and penalties is not limited to the SEC, they claim, because the Second Circuit’s reasoning would allow any regulator with examination authority, federal or state, to enforce the BSA.  And more regulators means more actions in more jurisdictions, which will result in “multiple—and potentially conflicting—regulatory regimes being imposed on financial institutions, increased compliance costs, less cooperation with FinCEN enforcement priorities and objectives, and more defensive SAR filings, to the detriment of law enforcement and national security efforts.”  Of course, many States already incorporate by reference FinCEN’s regulations under the BSA for the purposes of directly regulating and licensing various financial institutions, such as money transmitters and certain lenders.  Thus, the risk of potentially conflicting BSA interpretations and outcomes exists independently of the SEC.

Further, Freis and Steele argue that should they be subject to the SEC’s harsher penal structure, financial institutions will file SARs defensively to avoid the SEC “later unreasonably second-guess[ing] their decisions,” which will increase the amount of SARs filed, making “extracting useful intelligence” more difficult than it already is, thereby harming national security and law enforcement efforts.  However, the phenomenon of defensive SAR filing is already entrenched and well-known across all types of financial institutions covered by the BSA.

Finally, Freis and Steele make a very broad claim that allowing other state and federal agencies to enforce the BSA would “undermine FinCEN’s role on the global AML stage” because FinCEN has promoted best practices globally to center around transparency consistency and allowing other regulators to enforce the BSA would undercut that message, leaving the “United States less able to help shape global policy and share information in a centralized manner, damaging American interests and making it harder to stop cross-border financial crimes.”  There is a tension between this claim and the fact that the SEC is increasing actual BSA enforcement.  Further, there is a potential efficiency argument by the government in support of having a given financial institution’s BSA examiner and potential BSA enforcer be the same agency, rather than different agencies.

The CATO Brief

In addition to the FinCEN brief, CATO filed an amicus brief on August 20, 2021.  In the brief, CATO describes itself as a “nonpartisan public policy research foundation dedicated to advancing the principles of individual liberty, free markets, and limited government.”

CATO supports the petition for two central reasons.  First, CATO argues the petition raises “important questions involving delegation of legislative power, administrative accountability, and rulemaking transparency.”  According to CATO, the Treasury Department’s subdelegation of some of its BSA authority to the SEC, which itself incorporated by reference FinCEN’s own rules, raises governmental accountability issues.  Second, CATO argues the SEC’s adoption of Rule 17a-8, also known as “incorporation by reference,” violates the Administrative Procedure Act (“APA”).

The Lack of Administrative Accountability

CATO first explains the administrative framework surrounding the SEC, Treasury Department, and FinCEN as it relates to the BSA.  While the Securities Exchange Act of 1934 authorizes the SEC to create reporting obligations for broker-dealers, CATO notes one exception to this: all recordkeeping related to the BSA.  Congress delegated the authority to enforce BSA-related recordkeeping to the Treasury Department, not the SEC.  But, the Treasury Department invoked its authority to subdelegate to the SEC responsibility for examining broker-dealers.

Against this backdrop, CATO argues the SEC’s adoption of Rule 17a-8 leads to worsened administrative accountability and muddled governmental transparency.  In 1981, the SEC unconventionally imposed the obligation to make and preserve records relating to compliance with the BSA.  To do this, the SEC adopted Rule 17a-8.  According to CATO, this Rule “purports to incorporate by reference all existing and future rules promulgated by FinCEN in this area.”  CATO describes this process as a “circular redelegation” because the Treasury Department subdelegated part of its BSA authority to the SEC, which then incorporated by reference the rules of FinCEN, which is a branch of the Treasury Department.

CATO believes this “circular redelegation” raises “obvious accountability problems.”  Back in 1981, the Rule imposed no new substantive regulatory requirements and no new legal risk beyond what FinCEN already had in place.  But now, as CATO warns, the SEC has transformed into “an aggressive quasi-criminal prosecutorial office” with several mechanisms to enforce penalties.  As CATO puts it: “no one could have predicted in 1981 that the SEC would one day wield its current prosecutorial arsenal against broker-dealers for failing to file FinCEN-compliant Suspicious Activity Reports.”

To compound this problem, CATO contrasts FinCEN’s and the SEC’s enforcement authorities.  To enforce the BSA, FinCEN must show a defendant acted at least negligently, and the maximum penalty for negligent conduct is $1,180 per violation.  According to CATO, the SEC need not prove negligence, and the maximum violation can be as “high as $97,523 per violation.”  According to CATO, this disparity “can lead to wildly inconsistent positions enforcing the same legal requirement, as well as wildly inconsistent sanctions being imposed depending on which agency takes enforcement action.”  (CATO does not mention that FinCEN may seek penalties exceeding $57,000 for each violation if they are deemed by FinCEN to be “willful”).

The SEC’s Adoption of Rule 17a-8 Violates the Administrative Procedure Act

Next, CATO argues Rule 17a-8 violates the APA by allowing the SEC to “circumvent” its notice-and-comment rulemaking obligations.  This “rule-of-law” violation subverts transparency and accountability according to CATO.

CATO contrasts the delegation powers Congress afforded to the SEC and the Treasury Department.  Congress delegated the responsibility for writing broker-dealer recordkeeping rules to the SEC in the same legislation “through which it created the agency as an independent one largely insulated from political pressure and influence.”  Section 4(A)(a) of the Exchange Act specifies the SEC may delegate authorities to an SEC division, an individual commissioner, an administrative law judge, or an employee or employee board.  CATO notes neither FinCEN nor the Treasury are included within Section 4(A)(a)’s grant of delegation.  On the other hand, Congress gave the Treasury Department much broader delegation powers in the BSA.

After explaining the SEC’s narrow ability to delegate, CATO then attacks Rule 17a-8’s supposed abrogation of the APA’s notice-and-comment requirements.  These requirements, according to CATO, ensure that an agency will undertake “a careful and transparent public rulemaking process rather than evade that step by automatically accepting the judgment and processes of another agency.”

CATO addresses the Second Circuit’s opinion, explaining the court erred in assuming FinCEN will undertake its independent notice-and-comment process when it amends its own rules.  According to CATO, this assumption may lead to the SEC “brush[ing] off” its own rulemaking responsibilities.  CATO argues that before the SEC automatically adopts a new FinCEN rule, parties regulated by FinCEN and the SEC are entitled to object via the notice-and-comment process and judicial review.

According to CATO, the Second Circuit’s decision would lead to a slippery slope because no “obvious limiting principle” exists.  CATO warns, if the Second Circuit is correct, then nothing would prevent the SEC from incorporating by reference (via Rule 17a-8) the current and future rules of other federal agencies separate from FinCEN.  To highlight this concern, CATO explains an ESG disclosure bill recently passed the House of Representatives.  This bill is “chock full of dynamic incorporations by reference of lists and definitions from external statutes, agency rules, and international standards.”  This bill, the Corporate Governance Improvement and Investor Protection Act, also “invites” the SEC to “incorporate any internationally recognized, independent, multi-stakeholder environmental, social, and governance disclosure standards.”

CATO concludes no evidence suggests Congress intended to allow the SEC to enforce regulations from FinCEN’s rules on broker-dealers without vetting those rules through the notice-and-comment process under the APA.  According to CATO, these “abdications of congressionally delegated responsibility . . . should not be permitted.”

The CATO brief acknowledges, but does not address directly, the fact that FinCEN always engages in notice-and-comment process open to everyone before promulgating or amending any of its regulations, including those applicable to broker dealers incorporated through Rule 17a-8.  CATO appears to envision a “double” notice-and-comment period, in which industry may comment on a regulation proposed by FinCEN regarding broker-dealers, and then may comment again on a proposal by the SEC to incorporate by reference that same regulation.  Presumably, such a process would create the conflicting BSA standards feared by the amicus briefs, because the second notice-and-comment period (also open to regulators, law enforcement and watch dog groups) could change the regulations issued by FinCEN unless it functioned merely as a rubber stamp.  Further, the BSA regulations promulgated by FinCEN address the substance of BSA requirements, not procedural issues involving enforcement, so a second notice-and-comment period would not address the procedural concerns raised by the amicus briefs regarding the SEC ALJ system.

The SEC has until September 20, 2021 to respond to the petition.  Whether the SEC will respond to the petition and the amicus briefs piecemeal or all at once remains to be seen.

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