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Mutual Fund Suspicious Activity Reports

On April 27, 2006, the Department of the Treasury adopted regulations under the Bank Secrecy Act requiring all open-end investment companies (“mutual funds”) registered or required to be registered with the U.S. Securities and Exchange Commission (“Commission”) to report suspicious transactions to the Financial Crimes Enforcement Network (“FinCEN”). Under new Rule 103.15, any transaction involving at least $5,000 that a mutual fund knows, suspects, or has reason to suspect is designed to evade the Bank Secrecy Act, involves funds derived from illegal activities, has no apparent business or lawful purpose, or involves the use of the mutual fund to facilitate criminal activity, must be reported to FinCEN on Form SAR-SF.¹ Rule 103.15 was effective on June 5, 2006, and is applicable to trans-actions occurring after October 31, 2006.

Bank Secrecy Act

The USA PATRIOT Act expanded the scope of the Bank Secrecy Act to require financial institutions, including mutual funds, to report suspicious activities relevant to possible violations of law, including activities involving money laundering and international terrorism. In implementing the USA PATRIOT Act, FinCEN issued an interim final rule in April 2002 requiring mutual funds to develop and implement anti-money laundering programs designed to prevent funds from being used to launder money or finance terrorist activities. In May 2003, FinCEN and the Commission jointly adopted a rule requiring mutual funds to adopt and implement customer identification programs.² Since 2002, FinCEN has issued rules requiring other financial institutions, including banks, thrifts, and brokers-dealers to report suspicious activities. In January 2003, FinCEN proposed extending the suspicious activity reporting requirements to mutual funds.³

Reporting Requirements

Rule 103.15 obligates mutual funds to report any suspicious transaction “relevant to a possible violation of law or regulation.” The rule provides for both mandatory and voluntary reporting. A mutual fund may delegate reporting responsibilities to an affiliated or unaffiliated service provider; however, the mutual fund remains responsible for compliance with the rule.

Mandatory Reporting

A mutual fund is obligated to report suspicious transactions conducted or attempted by, at, or through the mutual fund that involve at least $5,000 in funds or other assets (whether or not the transaction involves currency) and that the mutual fund knows, suspects, or has reason to suspect:

1. involves funds derived from illegal activity or is intended or conducted to hide or disguise funds derived from such illegal activity as part of a plan to violate or evade any federal law or regulation or federal reporting requirement;
2. is designed, whether through structuring or other means, to evade the requirements of the Bank Secrecy Act or any rules under the Bank Secrecy Act;
3. has no business or apparent lawful purpose or is not the sort in which the particular customer would normally be expected to engage, and the mutual fund knows of no reasonable explanation after examining the available facts, including the back-ground and possible purpose of the transaction; or
4. involves the use of the mutual fund to facilitate criminal activity.

Voluntary Reporting

A mutual fund may report any suspicious transaction that it believes is relevant to a possible violation of any law or regulation, even if reporting is not required (e.g., if the suspected violation involves less than $5,000)

Determining Whether to File SAR-SF

In determining whether to file a SAR-SF, a mutual fund should consider all of the facts and circumstances relating to the transaction and the customer in question.⁴ FinCEN suggests that certain facts surrounding a trans-action indicate the need to file a SAR-SF. By way of example, FinCEN states that a SAR-SF may be required after a mutual fund closes an account and redeems shares when it cannot verify a customer’s identify because the customer (i) refuses to provide information necessary for identity verification or recordkeeping, (ii) provides information that the mutual fund determines to be false, or (iii) seeks to change or cancel a transaction after being informed of the verification and recordkeeping requirements. Whether to file a SAR-SF is a matter of judgment. A mutual fund’s determination should include whether the facts and circumstances and the mutual fund’s knowledge of the customer provides a reasonable basis for the transaction and removes it from the suspicious category.

Reporting Procedures

Who may file Form SAR-SF

Because affiliated or unaffiliated services providers may be in the best position to perform the reporting obligation, a mutual fund may contract with a service provider to file the SAR-SF as the mutual fund’s agent.⁵ However, the mutual fund remains responsible for compliance with the rule and must actively monitor the performance of its reporting obligations by the service provider. FinCEN suggests that a mutual fund that retains a service provider to file a SAR-SF on its behalf take steps to assure itself that the service provider has implemented effective compliance policies and procedures administered by competent personnel, and maintain an active working relationship with such compliance personnel.

Joint filings

More than one mutual fund may have an obligation to report the same suspicious transaction. In addition, other financial institutions, such as broker-dealers, may have separate obligations with respect to the same transaction. In those cases, a single joint SAR-SF may be filed by either a mutual fund or a financial institution on behalf of all of the mutual funds and other financial institutions involved in the transaction. The joint SAR-SF must contain all the relevant facts, include the names of each mutual fund and financial institution on whose behalf it is filed, and include the words “Joint Filing” in the narrative section. Each mutual fund and financial institution must keep a copy of the joint SAR-SF, along with any supporting documentation.

When must the report be filed

Form SAR-SF must be filed by a mutual fund (or another party filing on behalf of the mutual fund) within 30 calendar days of the initial detection of the suspicious transaction. If no suspect is identified on the date of the initial detection, a mutual fund may delay the filing for an additional 30 calendar days to identify the suspect, but must file a report no more than 60 calendar days after the date of initial detection. A mutual fund must immediately notify the appropriate law enforcement agency by telephone, in addition to filing a SAR-SF, in situations requiring immediate action, such as suspected terrorist financing or ongoing money laundering.

Confidentiality

The rule prohibits the disclosure to any person, other than FinCEN, the Commission, or other appropriate law enforcement or regulatory agencies, of information filed in, or the filing of, a SAR-SF, whether the report is required or is filed voluntarily.⁶ A mutual fund is prohibited from notifying the person involved in the transaction for which a SAR-SF has been filed.

The rule, however, does not prohibit a mutual fund from discussing with a service provider or another financial institution whether a joint SAR-SF should be filed and which party should file the form. A mutual fund also may provide information to the party performing the joint filing. In addition, a service provider that performs reporting obligations under contract with more than one mutual fund is not prohibited from sharing information as an agent of the mutual fund.

Limitation of Liability

Rule 103.15(e) restates the broad safe harbor, provided by the USA PATRIOT Act, from liability for making reports of suspicious activity, for nondisclosure of such reporting, and for voluntarily disclosing any possible violation of law or regulation to a government agency. This statutory protection also extends to agents filing SAR-SFs, including transfer agents and other service providers.

Retention of Records

Rule 103.15(c) requires mutual funds to maintain copies of each SAR-SF that they file or that are filed on their behalf (including joint filings), along with originals and copies of related documentation, for a period of five years from the date of filing. In addition, copies of each SAR-SF and supporting documentation must be made available to FinCEN, the Commission, and other appropriate law enforcement and regulatory authorities.

Footnotes

1. This obligation should not be confused with the requirement to report cash transactions totaling more than $10,000 to the Internal Revenue Service under 26 U.S.C. 60501 (“Form 8300”). Certain transactions may require a mutual fund to file both Form 8300 and Form SAR-SF
2. The rule implementing Section 326 of the USA PATRIOT Act requires mutual funds to adopt reasonable procedures to (1) identify persons seeking to open an account, (2) maintain records to verify the person’s identity, and (3) determine whether such persons appear on lists of known or suspected terrorists or terrorist organizations. See 68 FR 25131 (May 9, 2003)
3. See 68 FR 2716 (January 21, 2003). Form SAR-SF is the same form used by broker-dealers, futures commission merchants, and introducing brokers in commodities.
4. In the case of a transaction conducted through an omnibus account maintained by an intermediary, a mutual fund typically has little-to-no information about individual customers of the intermediary. For the purposes of this rule, the financial institution intermediary is a customer of the mutual fund.
5. If a service provider files Form SAR-SF as agent for a mutual fund, the service provider should designate the mutual fund as the reporting financial institution on Form SAR-SF.
6. Any person subpoenaed or otherwise required to disclose information contained in the SAR-SF, including a jointly filed SAR-SF, must decline to produce the SAR-SF or to provide any information that would disclose that a SAR-SF has been prepared or filed, and must notify FinCEN of the request and the response to the request.

For More Information

Please contact any of our lawyers or any member of our Corporate Transactions & Securities practice group for more information.

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