Firms Scramble Ahead of SEC Decision to Comply With Law

Fund companies are making their lists and checking them twice - for the Patriot Act.

While the Treasury Dept. has offered a temporary reprieve, funds are working to put new procedures and systems in place to adhere to new requirements mandated by President Bush's Patriot Act. In addition to periodically checking the names and addresses of those identified by the Department of the Treasury's Office of Foreign Assets Control (OFAC) in Washington as being suspect individuals with ties to money laundering and/or funding of terrorist activities, fund companies will soon be on the hook for verifying the identities of all fund account holders, new and existing, and validating the personal information they submit through a "Customer Identification Program."

Funds will need to implement "reasonable procedures" to verify the legitimacy of their investors, "to the extent reasonable and practical," and maintain records of such verification, according to the Act.

If individuals are identified as potentially questionable, fund companies will be responsible for reporting their names to the authorities. Penalties for criminal violations of the new requirements carry fines up to $1 million and 12 years in jail, as well as civil monetary penalties.

$11 Billion Tab

Anti-money laundering initiatives, spurred on by the Patriot Act, are expected to cost the financial services industry a cool $11 billion through the end of 2005, according to Celent Communications, a financial research and advisory firm in Boston. Moreover, the largest expense, 64%, or $7 billion, is expected to be go toward compliance spending. Of the $11 billion, 30%, or $3.3 billion, will go toward training employees and filing the reports, and 6% will be spent on actual computer system upgrades.


Post 9/11

Talk to most fund company executives, and they will readily admit that being in full compliance with the new mandate is a daunting task. "From a system's perspective, it's an incredibly big job to change even one field on a system because of all of the implications of that information," said Bob Grohowski, assistant counsel with the Investment Company Institute. Besides verifying account-holder information, all mutual fund applications have to be pulled back, reprinted, then sent back to the various distribution channels because information, such as previously unrequested dates of birth, driver's license identification numbers and passport numbers, will need to be recorded. It's a logistics nightmare, Grohowski added. Further, funds will be required to disclose to investors how they will be using the newly requested information.

Final regulations from both the SEC and Department of the Treasury were scheduled to be finalized and take effect this Friday. But on Oct. 11, the Treasury announced it was delaying compliance until regulations could be finalized. There are 3,060 fund advisors registered with the SEC. While there is no official word yet back from the regulators, they seem to be open to the idea of a "grace period," Grohowski said.

Both fund companies and the transfer agents who preside over fund investor records and account information aren't waiting until the 11th hour. Most are busy arming shareholder recordkeeping systems with new capabilities.

No-Load Challenge

At Saturna Capital Corp. in Bellingham, Wa., adviser to the two Amana Funds, which invest according to Islamic principles, and the non-Islamic Sextant Funds, fund prospectuses already contain account applications that require dates of birth and driver's license or passport ID numbers, and the fund boards have already approved the group's policies and procedures, said Nick Kaiser, president of Saturna.

It's a challenge for no-load funds, he said. "It's hard to know your customer when they are nothing more than a mail application and a check." He expects that the Social Security Bureau will need to allow funds and fund transfer agents to access their system to verify identities. But access will also have to be cost-efficient for smaller funds, he said.

One of the challenges to funds and transfer agents in comparing investor names and addresses to the OFAC list of "Specially Designated Nationals" is that it is constantly in flux, often updated, and not user-friendly, said Fred Marius, president of Quantitative Advisors of Lincoln, Mass., adviser to the Quant Funds as well as proprietor of Fund Resource, which provides back-office technology to funds.

Fund Resource has developed a system that automatically takes a mutual fund group's shareholder records or a feed from a transfer agent, then runs the list through a Fund Resource computer, matching up all investors against the OFAC and other suspicious person lists. It red-flags both perfect matches or close matches for a fund company's compliance department to follow up on.

The system can verify up to 350,000 shareholder records for potential matches in about 50 minutes and can run overnight, during most mutual fund's down time, either automatically or manually. The cost for a large list runs between $1,000 to $2,000 per month based upon the number of accounts, Marius said. But the system is expandable to also match up against folks known to have floated bad checks or other undesirable activities, even in other countries.

The firm is now developing a system that fund companies can plug into any in-house PC, allowing them to match shareholder records themselves. The system will be capable of running one million account names against designated and daily updated lists in about five minutes. Marius said he is looking at ways to verify investors' information by matching up information to government agencies, once investor identification rules are finalized.

Big industry transfer agents, including DST of Kansas City and PFPC of Wilmington, Del., are ready to rock.

Three years ago, DST built identity-checking capabilities onto its TA-2000 system, which has since matched investor names from its client mutual funds against OFAC, as well as lists containing persons suspected of fraud or other suspicious activities, said Frank Imgrund, director of systems development. Moreover, DST is enhancing its system to detect patterns of activities that may indicate money laundering is taking place.

DST isn't only enhancing but building in flexibility so that fund advisors can set opt-out parameters, designating specific blocks of accounts, such as fund employees, that don't need verification.

Corporate accounts may give funds the biggest headaches, Imgrund said. "They will need to collect personal information from anyone who has the authority to put money in or take money out of an account," he said. But numerous people may be authorized at any one company, and authorized officers can change frequently, he added.

PFPC, by virtue of already providing the transfer agency for its parent, PNC Bank, is an old hat at following anti-money laundering procedures, including matching to OFAC, SEC lists and foreign government lists, looking for suspicious patterns and combinations of money flows, as well as cash equivalents, money orders and even travelers checks, said Steve Turowski, senior vice president of the transfer agency at PFPC. One concern among those fund clients that distribute funds through intermediaries is who is ultimately responsible for verifying the clients identity - the fund company or the financial advisor, Turowski said.

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