CSP023 MAY 2020 Anti-Money Laundering and Blockchain Technology CHUNG-CHIA HUANG AND ASHER TRANGLE Memorandum FROM: Director of FinCEN TO: Junior FinCEN Lawyer RE: Recommendations Regarding Reforming BSA/AML Compliance DATE: January 26, 2020 Welcome to your new position as a junior attorney at FinCEN. FinCEN plays a critical role in monitoring and enforcing financial crimes involving banks and other financial institutions. The organization takes this role very seriously, and we are proactively seeking more effective ways of detecting illegal activity and fighting financial crime. Over the past year, I have been monitoring articles and suggestions regarding how to improve or reform anti-money laundering laws. As new technologies develop, a number of startups are using blockchain technology with the goal of helping financial institutions comply with U.S. anti-money laundering (AML) laws. Financial institutions are eager to test whether blockchain technology products can simultaneously improve or increase their compliance with AML laws while reducing the enormous costs associated with the current AML framework. I want you to look into what types of reforms, if any, FinCEN should seriously consider adopting. In particular, please research the viability of new technologies, such as blockchain and/or machine learning, for changing our regulatory approach and make a recommendation as to whether FinCEN should support the adoption of such technologies for AML compliance. Please note that there may be other data sharing systems or technologies (e.g. permissioned ledgers) that have also been mentioned with respect to increasing the efficiency of AML compliance. Include the pros and cons of adopting your recommendations. I am certain that you understand the importance of FinCEN’s role in the enforcement community; we are on the front lines of fighting financial crimes and cutting off funding for terrorist organizations and terrorist attacks. Adopting new technology to help combat these crimes may be very helpful—if not imperative—in the future. However, FinCEN cannot Written by Chung-Chia Huang and Asher Trangle under the supervision of Howell E. Jackson, James S. Reid, Jr., Professor of Law at Harvard Law School. Case development at Harvard Law School is partially funded by a grant from Dechert LLP. Cases are developed solely as the basis for class discussion. They are not intended to serve as endorsements, sources of primary data, legal advice, or illustrations of effective or ineffective management. Copyright © 2020 President and Fellows of Harvard University. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without permission. To order copies or permissions to reproduce materials please visit our website at casestudies.law.harvard.edu or contact us by phone at 617-496-1316, by mail at Harvard Law School Case Studies Program, 1545 Massachusetts Avenue – Areeda 507, Cambridge, MA 02138, or by email at [email protected]. ANTI-MONEY LAUNDERING AND BLOCKCHAIN TECHNOLOGY CSP023 support the use of new technology by financial institutions if it means less-effective monitoring or enforcement. I would like your recommendation on my desk as soon as possible. I have had our analysts compile the following primer to help bring you up to speed on these issues. Origins of the Bank Secrecy Act and Subsequent Legislation FinCEN is a bureau of the U.S. Department of the Treasury and is tasked with safeguarding the financial system from illicit use and combating domestic and international financial crimes, including money laundering and terrorist financing.1 As a feature of its enforcement powers, FinCEN is the designated administrator of the Bank Secrecy Act of 1970 (BSA) and the subsequent laws enhancing and amending the BSA.2 The goal of the BSA compliance scheme is to encourage financial institutions to help identify the source, volume, and movement of currency flowing through those financial institutions.3 As initially conceived, the BSA was implemented as a way to fight the drug trade in the 1970s, as drug dealers were using the financial system to divert profits from illegal operations to legitimate sources.4 To combat this money laundering, authorities sought to “follow the money” and establish a paper trail of all customer transactions in an effort to make it far more difficult for drug dealers to launder profits.5 To accomplish this, the BSA established recordkeeping and reporting requirements like the Consumer Transaction Report (CTR) for all deposits, withdrawals, exchanges, or transfer of funds over $5,000 (since increased to $10,000).6 Since 1970, numerous other laws have been enacted by Congress enhancing and amending the BSA to provide FinCEN and other regulatory agencies with the most effective tools to detect and prevent money laundering and other financial crimes.7 The Money Laundering Control Act of 1986 (MLCA) directed financial institutions to establish and maintain procedures designed to reasonably monitor and ensure compliance with the reporting and recordkeeping requirements of the BSA while imposing sanctions on financial institutions that assisted customers in laundering money.8 Later, the Annunzio-Wylie Anti-Money Laundering Act of 1992 expanded the concept of the CTR and required financial institutions to file reports whenever they detected suspicious activity.9 The Annunzio-Wylie Act also granted the U.S. Treasury broad authority to create AML regulations and demand reports for any violation of law or regulation.10 In the wake of the September 11, 2001 terrorist attacks, Congress passed the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (Patriot 1 Mission, FINCEN, www.fincen.gov/about/mission [perma.cc/LJX2-ARFE] (last visited Oct. 30, 2016). 2 FinCen, History of Anti-Money Laundering Laws, FINCEN, www.fincen.gov/history-anti-money-laundering-laws [perma.cc/Q9QL- R9FB] (last visited Oct. 30, 2016). 3 FFIEC, Bank Secrecy Act Anti-Money Laundering Examination Manual: Introduction, FED. FIN. INSTITUTIONS EXAMINATIONS COUNCIL, www.ffiec.gov/bsa_aml_infobase/pages_manual/OLM_002.htm [perma.cc/D99L-QUQE] (last visited Oct. 30, 2016); [hereinafter Fed. Fin. Institutions Examinations Council will be referred to as FFIEC). 4 Stavros Gadinis and Colby Mangels, Collaborative Gatekeepers, 73 WASH. & LEE L. REV. 797, 859 (2016) (citing Peter E. Meltzer, Keeping Drug Money From Reaching the Wash Cycle: A Guide to the Bank Secrecy Act, 108 BANKING L.J. 230, 231 (1991)). 5 Id. 6 See FFIEC, supra note 3; Gadinis & Mangels, supra note 4, at 859-60. 7 FinCEN, supra note 2. 8 See Money Laundering Control Act, Pub. L. No. 99-570, 100 Stat. 3207, § 1359; FFIEC, supra note 4; Gadinis & Mangels, supra note 4, at 861. 9 31 U.S.C. § 5318(g) (2012) (the Annuzio-Wiley Act's “Reporting of Suspicious Transactions” provision); Gadinis & Mangels, supra note 4, at 869-70. 10 Gadinis, supra note 4, at 869-70. 2 ANTI-MONEY LAUNDERING AND BLOCKCHAIN TECHNOLOGY CSP023 Act), which imposed striking new requirements on financial institutions as part of the broader goal to combat terrorism.11 The Patriot Act included provisions to expand AML requirements to all financial institutions subject to U.S. regulatory jurisdiction, provide the Secretary of Treasury with the authority to impose “special measures” on financial institutions that are of “primary money-laundering concern,” augment the existing BSA framework by strengthening customer identification procedures, impose a 120 hour period in which financial institutions must respond to regulatory requests for information, and improve information-sharing between financial institutions and the U.S. government.12 Aside from FinCEN, other federal agencies also shoulder responsibility for enforcing aspects of overall U.S. AML policy. For example, the Department of Justice (DOJ), focuses on the criminal aspect of the AML laws, investigates and brings charges against those laundering money. The DOJ not only targets natural persons who commit crimes, but also has power to investigate and prosecute financial institutions and their officers, directors, and employees.13 Their investigations mostly lead to non-prosecution agreements or deferred-prosecution agreements. Bank regulators are also a crucial component of AML compliance schemes. Bank regulators execute examinations, whether on-site or off-site, to ensure the regulated banks are in compliance with prudential standards. On top of that, examinations would also include some AML aspects, such as whether the bank follows certain process or standards.14 The Current AML Compliance Regime The current AML compliance regime has several important requirements that impose obligations on financial institutions. The key features of AML compliance include requirements that financial institutions file currency reports with the U.S. Department of the Treasury,15 report suspicious transactions through Suspicious Activity Reports (SAR),16 properly identify persons conducting transactions and opening bank accounts through customer identification programs (CIP—this compliance technique is commonly referred to as “know your customer” or “KYC”),17 and maintain a paper trail by keeping appropriate records of financial transactions.18 These features are designed to enable law enforcement and regulatory agencies to pursue investigations of criminal,