FINRA & OFAC: What Brokerage Firms Need to Know About Compliance this Year (and Beyond)
Brokerage firms are subject to numerous compliance obligations. While most brokerage firm executives are generally familiar with the obligation to comply with the rules and regulations promulgated by the U.S. Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA), far fewer have a sufficient understanding of Office of Foreign Assets Control (OFAC) compliance.
FINRA and OFAC compliance overlap in certain respects. As a result, by thoroughly addressing their compliance obligations under FINRA’s rules and the federal securities statutes, brokerage firms will meet some of their OFAC compliance obligations by default. However, there is also much more to OFAC compliance; and, without a targeted and custom-tailored OFAC compliance program, brokerage firms will face the risk of enforcement exposure and substantial liability.
“OFAC compliance is critical for brokerage firms and other entities in the securities industry. As OFAC continues to play a larger role in regulating cross-border financial transactions involving U.S. parties and intermediaries, brokerage firms that fail to adequately address OFAC compliance will place themselves at risk for investigations and enforcement actions.” – Dr. Nick Oberheiden, Founding Attorney of Oberheiden P.C.
So, what does it take for brokerage firms to adequately address not only their FINRA compliance obligations, but also their OFAC compliance obligations? To begin, we’ll discuss some of the key areas in which FINRA and OFAC compliance overlap. Then, as brokerage firm executives tend to be more familiar with FINRA compliance, we’ll highlight some of the key aspects of OFAC-specific compliance as well.
The Overlap Between FINRA and OFAC Compliance
First, we’ll discuss why FINRA and OFAC compliance overlap in certain respects. This will set the stage for our discussion, and it will help to frame both the similarities and differences between brokerage firms’ compliance obligations in each area.
FINRA’s Rules and the federal securities statutes that FINRA enforces apply to brokerage firms. As a quasi-governmental agency, FINRA works alongside the SEC to regulate the securities industry in the United States, and it is tasked specifically with regulating the conduct of brokerage firms and individual broker-dealers. Within its capacity as a securities regulator, FINRA’s primary focus is on protecting investors; and, to this end, FINRA focuses on enforcing brokerage firms’ and broker-dealers’ obligations in the areas of licensure, recordkeeping, and disclosure.
In contrast to FINRA, OFAC’s primary focus is on protecting national security and promoting the foreign policy interests of the United States. OFAC is tasked with regulating cross-border transactions involving U.S. parties and intermediaries; and, through its sanctions programs, OFAC prohibits many foreign parties (including individuals, companies, and governmental entities) from transacting business through the U.S. financial system. Crucially, when a foreign party or its assets are “blocked,” not only is the party restricted from engaging in financial transactions involving U.S. parties or intermediaries, but U.S. parties and intermediaries have an obligation to avoid doing business with the foreign party as well.
One of the clearest areas of overlap between FINRA and OFAC compliance is anti-money laundering (AML) compliance under the Bank Secrecy Act (BSA). The BSA applies to “financial institutions”—a term that is broadly defined and that includes brokerage firms. Brokerage firms must ensure strict compliance with the BSA; and, in doing so, they must address issues that have the potential to lead to scrutiny from both FINRA and OFAC. For example, some areas of BSA (and AML) compliance that are of concern to both of these regulators include:
- Know-Your Customer (“KYC”) Compliance – FINRA and OFAC both expect brokerage firms to take adequate steps to identify their customers (though for different reasons). While FINRA expects brokerage firms to effectively manage KYC compliance in order to prevent investor fraud, OFAC expects brokerage firms to identify their customers in order to avoid doing business with sanctioned parties.
- Transaction Clearance Compliance – Transaction clearance is critical for both FINRA and OFAC compliance as well. Brokerage firms must ensure that they are not exposing their customers to fraud to satisfy FINRA, and they must ensure that they are not executing transactions involving “blocked” assets to satisfy OFAC.
- Transaction Reporting Compliance – Under the BSA, brokerage firms must report certain customer transactions in order to maintain both FINRA and OFAC compliance. Note, however, that brokerage firms may owe additional transaction reporting obligations to OFAC as well. For example, brokerage firms (and other parties) must generally report transactions that they block or reject based on OFAC’s sanctions.
- Recordkeeping Compliance – FINRA and OFAC both expect brokerage firms to maintain various records as part of the compliance management process. Brokerage firms must maintain internal, customer, and transaction records (among others), and they must do so in such a way that they can efficiently demonstrate compliance to FINRA or OFAC when necessary.
- Compliance Documentation – FINRA and OFAC also both expect brokerage firms to implement effective compliance policies and procedures. During audits and investigations, both will expect brokerage firms to be able to produce copies of their compliance documentation, including proof of employee training. Since FINRA and OFAC compliance overlap in some, but not all, respects, policies and procedures that satisfy one of these regulators won’t necessarily satisfy the other.
Again, these are just examples. FINRA compliance and OFAC compliance both present substantial burdens for brokerage firms; and, even where there is overlap, brokerage firms may still need to address each regulator’s expectations separately. Since FINRA and OFAC have different enforcement mandates and priorities, they have different expectations—and this means that compliance efforts that are sufficient to maintain FINRA compliance may not (and likely will not) be enough to maintain OFAC compliance, and vice versa.
OFAC Compliance: A Key Concern for Brokerage Firms This Year (and Beyond)
As we’ve discussed, while FINRA and OFAC compliance overlap in certain respects, there are also numerous unique aspects to OFAC compliance for brokerage firms. This year (and beyond), simply focusing on FINRA compliance is not enough. As transactions cross international borders with increasing frequency, OFAC compliance continues to take on heightened importance, and OFAC has shown a willingness to hold entities of all sizes accountable through enforcement actions in recent years.
With this in mind, what do brokerage firms need to know about OFAC-specific compliance this year (and beyond)? Some of the key areas of concern in the brokerage industry include:
- OFAC Sanctions Screening – OFAC administers four primary sanctions programs. Under each of these programs, numerous individuals and entities around the world are subject to sanctions that prohibit brokerage firms from executing transactions on their behalf. While the most well-known of these sanctions programs is the Specially Designated Nationals (SDN) List, SDN List screening is just one aspect of overall OFAC sanctions compliance.
- OFAC License Compliance – In certain circumstances, brokerage firms (and other parties) can execute transactions involving sanctioned parties under OFAC’s general licenses. These are regulatory issuances that permit specific transactions that would otherwise be blocked under an OFAC sanctions program. If no general licenses apply, it may still be possible to execute a transaction involving a blocked party or blocked assets by obtaining a specific license from OFAC. However, this can be a time-intensive process, and jumping the gun can expose brokerage firms to enforcement action.
- Transaction Blocking and Rejection Compliance – Under OFAC’s sanctions programs, U.S. parties are generally prohibited from doing business with blocked parties or facilitating transactions that involve blocked assets. Brokerage firms must manage these obligations proactively; and, when a brokerage firm blocks or rejects a transaction pursuant to OFAC’s sanctions, it must report this action to OFAC in a timely manner. Even if a brokerage firm appropriately blocks or rejects a transaction, failure to report the action to OFAC can still lead to unwanted scrutiny.
- Appointment of an OFAC Compliance Officer – While OFAC does not establish specific requirements for U.S. parties’ compliance programs, it provides recommendations in A Framework for OFAC Compliance Commitments. One of these recommendations is to appoint an OFAC compliance officer. Depending on a brokerage firm’s size and the scope of its international business, this individual may serve in other roles as well (i.e., as the firm’s FINRA compliance officer), or this may need to be a stand-alone position. Although not strictly required, if a brokerage firm does not have an appointed OFAC compliance officer, this will raise flags during an investigation or enforcement proceeding.
- Voluntary Self-Disclosure of Apparent Violations – If a brokerage firm inadvertently conducts business with a sanctioned party or facilitates a transaction involving blocked assets, it generally has an obligation to voluntarily self-disclose the “apparent violation” to OFAC. Failure to voluntarily self-disclose apparent violations can not only lead to enhanced scrutiny, but it can increase the maximum penalties for OFAC sanctions violations as well.
Here, too, these are just examples. OFAC compliance is complex, and effectively managing OFAC compliance requires an informed, proactive, and custom-tailored approach. While violating OFAC sanctions presents substantial risks for brokerage firms (and potentially their owners and executives), it is possible to effectively manage these risks with a top-down commitment to compliance at all levels of a brokerage firm’s operations.
Dr. Nick Oberheiden, founder of Oberheiden P.C., focuses his litigation practice on white-collar criminal defense, government investigations, SEC & FCPA enforcement, and commercial litigation.