U.S. SEC Extends the Customer Identification Program No-Action Letter for Broker-Dealers and Changes the Terms

February 17, 2011

On January 11, 2011, the U.S. Securities and Exchange Commission ("SEC"), in consultation with the Department of the Treasury, Financial Crimes Enforcement Network ("FinCEN"), again extended the Bank Secrecy Act ("BSA") Customer Identification Program ("CIP") no-action letter (initially issued in 2004) relating to broker-dealer reliance on SEC registered investment advisers ("RIAs").  As previously, the extension was granted at the request of the Securities Industry and Financial Markets Association ("SIFMA").

Under the terms of the no-action letter, if certain criteria are met, the SEC will not take an enforcement action against a broker-dealer who reasonably relies on an RIA to perform the broker-dealer’s CIP obligations with respect to the RIA’s customers who have accounts with the broker-dealer.  Under the CIP requirements for broker-dealers, broker-dealers are protected from liability for CIP violations if they enter into a reliance agreement that meets the regulatory criteria with another financial institution that is regulated by a federal functional regulator and subject to the BSA Anti-Money Laundering ("AML") Program requirements.  31 C.F.R. § 103.22(b)(6).  Because RIAs themselves are not yet subject to AML Program requirements under the BSA, the no-action letter is necessary to afford the same protection from liability for reliance agreements with RIAs.

Action Required and Timing

It is important to note that the SEC has made the terms of CIP reliance agreements with RIAs that qualify for application of the no-action letter more extensive and restrictive.  These new provisions will require broker-dealers to amend the terms of their current CIP reliance agreements with RIAs.  In the no-action letter, the SEC provides that broker-dealers have until May 11, 2011 (120 days) to become compliant with the new terms.  Until that time, reliance agreements meeting the terms of the previous CIP no-action letter (January 11, 2010) may remain in force.  If RIAs do not become subject to AML Program requirements by January 11, 2012, the SEC would need to extend the no-action letter again next year.

Old Terms v. New Terms

As before, a U.S. investment adviser must be registered with the SEC; reliance on the particular RIA must be reasonable under the circumstances; the RIA must enter a contract with the broker-dealer requiring it to certify annually to the broker-dealer that the RIA has implemented an AML Program consistent with 31 U.S.C. §5318(h); and the RIA (or its agent) must agree to perform the specified requirements of the broker-dealer’s CIP.

Under the revised no-action letter, there are additional requirements that broker-dealers must meet in order for the protection of the no-action letter to apply:

• The RIA must not only certify that it has implemented an AML Program consistent with 31 U.S.C. §5318(h),  but that it will update its AML Program to implement changes to applicable laws or guidance.
• The RIA must certify that it will perform CIP consistent with Section 326 of the USA Patriot Act (the BSA statutory authority for the CIP requirements for broker-dealers and other financial institutions).
• The RIA must agree to disclose promptly to the broker-dealer potentially suspicious or unusual activity detected as part of the CIP being performed so that the broker-dealer can file a Suspicious Activity Report ("SAR"), "as appropriate," based on the broker-dealer’s judgment.
• The RIA must agree to disclose its books and records related to its CIP performance to the SEC, the SRO, and/or authorized law enforcement agencies, either directly or through the broker-dealer, at the request of the broker-dealer, the SEC, the SRO and/or an authorized law enforcement agency.
• The RIA must certify annually that the representations in the reliance agreement remain accurate and that it is in compliance with the representations.

Notably, while implicit in the concept of reasonable reliance, the SEC stated explicitly that reasonable reliance is predicated on a broker-dealer’s undertaking appropriate risk-based due diligence on the RIA commensurate with the money laundering risk of the RIA and the RIA’s customer base.

The SEC acknowledges that the new terms may cause some broker-dealers not to renew their CIP reliance agreements with RIAs, i.e., to conduct CIP on the RIA clients themselves.

No Need for Extension by CFTC

In 2005, the Commodities Futures Trading Association issued a CIP no-action letter which has similar terms to the 2010 SEC no-action letter, with respect to reliance by Futures Commission Merchants on registered Commodities Trading Advisers.  That letter remains in effect.

© 2011 Gibson, Dunn & Crutcher LLP

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