Bitcoins and SAR Narratives

You probably know about Bitcoin, unless you have been living in total seclusion for the last few years. The big controversy usually centers on determining if it is legal tender. But imagine if you are confronted with a transaction involving Bitcoin. Do you file a Suspicious Activity Report (“SAR”)?  

It so happens that the Financial Crimes Enforcement Network (“FinCEN”) has been giving that very concern laser-like attention! In July 2014’s “SAR Stats,” FinCEN observed that the “rapid adoption and price fluctuation of Bitcoin” has put convertible virtual currencies in the spotlight over the past year.[1] The same attributes of virtual currencies that attract lawful users, such as the capacity for anonymity as well as their speed and global reach, attract criminal actors engaged in illicit financing. FinCEN is observing a rise in the number of SARs flagging virtual currencies as a component of suspicious activity. Bitcoin is considered one of the “emerging payment methods.” Consequently, it is important to understand virtual currencies in order to properly complete the SAR Narrative. 

So let’s define Bitcoin. 

Bitcoin is a type of virtual currency. It is also known as a crypto-currency or a math-based currency or digital currency. A virtual currency is considered “decentralized” because it allows users to conduct transactions peer-to-peer without a central administrator. It is a software-based payment system described by one Satoshi Nakamoto in 2008,[2] and introduced as open-source software in 2009. Payments are recorded in a “public ledger” using its own unit of account, which naturally is also called Bitcoin. Payments work peer-to-peer without a central repository or single administrator - which has led the US Treasury to call Bitcoin a “decentralized virtual currency.”[3]  

In keeping with the general architecture of the Internet, transactions and new currency issuances are conducted without a central administrator or trusted third party. Instead, as an open-source software, its protocol links users into a network that: (1) secures the network from attack; (2) broadcasts transactions; (3) verifies and settles transactions; (4) issues new currency; and (5) publishes new transactions to a shared, “distributed ledger of all transactions” called the “block chain.”[4] The rate of coin creation, the total Bitcoin to be created (say, 21 million), and other variables (viz., network difficulty adjustments), are also in the software protocol. Other crypto-currencies may differ on the basis of these and other variables.[5] 

Besides “mining,” Bitcoins can be obtained in exchange for fiat money, products, and services. Users send and receive Bitcoins electronically for an optional transaction fee using wallet software on a personal computer, mobile device, or a web application.[6] Mining is the maintaining of the block chain, and those who do so are rewarded with newly created Bitcoins and transaction fees. Miners may be located anywhere in the world; they process payments by verifying each transaction as valid and adding it to the block chain.[7]

FinCEN’s view of SAR data and Bitcoin transactions 

Financial institutions, including, but not limited to, Virtual Currency Exchangers, other Money Transmitters, other types of Money Services Businesses, and Depository Institutions may all be involved in the chain of transactions making up the lifecycle of a user’s purchase, use and sale of Bitcoin for currency of legal tender.[8] FinCEN regards SAR data “crucial in assessing transactions involving Bitcoin or other virtual currencies.”[9] Indeed, any financial institution that is required to file a SAR and accepts transactions in Bitcoin should be giving consideration not only to the SAR filing mandates but also sharing information relating to such virtual currency transactions. FinCEN encourages the use of information sharing under 314(b) in this context.[10] 

Bitcoin has seen its share of black market activity. There has been increasing FinCEN and law enforcement scrutiny regarding the use of Bitcoin for illegal activities.[11] In October 2013 the FBI shut down the “Silk Road”, allegedly an online black market, and seized 144,000 Bitcoins worth $28.5 million at the time.[12] Although the United States is still considered “Bitcoin-friendly” compared to other governments, in China buying Bitcoins with Yuan is subject to restrictions, and Bitcoin exchanges are not allowed to hold bank accounts.[13] 

Different financial institutions are more likely to see different elements of the same suspicious activity due to their participation in and perspective on the transaction chain.  

According to FinCEN, while Depository Institutions do not currently interact directly with the Bitcoin economy (i.e., accepting deposits in Bitcoin, conducting transactions in Bitcoin, and so forth), they may see cash, ACH, or Wire and Funds Transfer deposits and withdrawals associated with the following entities, as outlined in the SAR Stats. 

Anti-Money Laundering Program for RMLOs

A new era in filing requirements is about to begin. For the first time, the Financial Crimes Enforcement Network, known as “FinCEN,” will require nonbank mortgage lenders and originators to implement an Anti-Money Laundering program (“AML Program”) and file Suspicious Activity Reports (“SARs”) for certain loan transactions.[i] FinCEN is establishing this AML program in accordance with the Bank Secrecy Act (“BSA”).[ii] The guidelines relating to the AML requirement become effective on April 16, 2012, and the AML Program’s effective compliance date is August 13, 2012.[iii] The AML program and SAR filing regulations, which I will refer to as “FinCEN’s rule,” are considered to be “the first step in an incremental approach to implementation of regulations for the broad loan or finance company category of financial institutions.” [iv]

 

The Bank Secrecy Act defines the term "financial institution" to include, in part, a loan or finance company. This terminology, however, can reasonably be construed to extend to any business entity that makes loans to or finances purchases on behalf of consumers and businesses. Thus, nonbank residential mortgage lenders and originators, and mortgage brokers, are grouped into the "loan or finance company" category.[v] However, the term ‘‘loan or finance company’’ is actually not concisely defined in any FinCEN regulation, and there is no legislative history on the term itself. Nevertheless, FinCEN is applying this term to extend to any business entity that makes loans to or finances purchases on behalf of consumers and businesses. [vi] Therefore, residential mortgage lenders and originators (“RMLOs”) are covered by the scope of the ‘‘loan or finance company’’ term. I will use the acronym “RMLO” in this article, inasmuch as my principal focus herein relates to residential mortgage lenders and originators.

 

FinCEN can issue regulations requiring financial institutions to keep records and file reports that are determined to have a high degree of usefulness in criminal, tax, or regulatory investigations or proceedings, or in the conduct of intelligence or counterintelligence activities, including analysis, to protect against international terrorism. Federally regulated depository institutions have been required to have AML Programs,[vii] and now, as of the aforementioned effective compliance date, RMLOs must also comply with FinCEN’s regulations relating to implementing an AML Program and the filing of SARs.

 

Over the last few years,[viii] FinCEN has issued studies and analyses that used SARs to discover suspected mortgage fraud and money laundering that involved both banks and residential mortgage lenders and originators.[ix] According to FinCEN, these reports “underscore[d] the potential benefits of AML and SAR regulations for a variety of businesses in the primary and secondary residential mortgage markets.”[x]

 

Residential mortgage lenders and originators, the RMLOs, are considered to be the primary providers of mortgage finance, and have a unique position with respect to direct contact with the consumer. Thus, they are presumably able to assess and identify money laundering risks and fraud.[xi] At this time, FinCEN is not proposing a definition of “loan or finance company’’ that would encompass other types of consumer or commercial finance companies, or real estate agents and other entities involved in real estate closings and settlements.

 

In this article, I am going to unpack the AML Program for you in a way that will give you some familiarity with its scope, while perhaps also making its implementation a bit less daunting than it might otherwise seem to be. Nevertheless, many RMLOs will find that setting up the AML Program will be a challenging endeavor. Information, issuances, and relevant documentation are available in the FinCEN section of my firm’s website Library.

 

Please keep in mind that, as is the case with many applications of legal and regulatory compliance, there are aspects and nuances that will require recourse to a competent risk management professional to obtain comprehensive guidance and reliable information.[xii]

 

AML PROGRAM

 

Residential mortgage lenders and originators, the RMLOs, are required to establish an AML Program that includes, at a minimum:

 

(1) Development of internal policies, procedures, and controls.

(2) Designation of a compliance officer.

(3) Ongoing employee training program.

(4) Independent audit function to test for compliance.