Articles Key Takeaways from Manhattan Federal Court’s Denial of Banco de San Juan International Inc.’s “Right” To A Master Account By Aixa Maldonado-Quinones | November 6, 2023 This article has been updated. Click here to view. Puerto Rico’s international financial and banking entities (“IFEs and IBEs”) rely on master accounts to access the Federal Reserve’s (“the Fed”) payments system and offer their foreign clientele check clearing, wire transfer, and automated clearing house services without the need for intermediary banks. The typical traditional bank application is reviewed and granted within days. But for non-traditional institutions, like island IFEs and IBEs, the master account application and approval process has become an arduous and painstaking one, fraught with uncertainty. Review delays, account suspensions, requests for information, and the uncertainty of termination has led to consternation and disincentivized investors from moving to the island. To date, ten Puerto Rican IFEs and IBEs have master account applications pending before the Federal Reserve Bank of New York (“FRBNY”), four of which have been pending since 2020. But for the resilient few who choose to stay and fight the fight there is hope – if you’re willing to do the work. A number of years back, several non-traditional banking entities (i.e., crypto asset custodians) questioned the policies behind the eligibility to a Fed master account. Knowing that its application and review process was burdened with lack of transparency and inconsistencies, in August 2022 the Federal Reserve Board published certain Guidelines for Evaluating Account and Services Requests to ensure that regional Reserve Banks evaluate a transparent and consistent set of risk-focused factors when reviewing account requests. The Guidelines include a tiered review framework to provide additional clarity on the level of due diligence and scrutiny that Reserve Banks should apply when reviewing access requests from different types of institutions. Reserve Banks are also required to consider six principles, the fifth of which (Principle 5) is whether providing the account and services would create “undue risk to the overall economy by facilitating activities such as money laundering, terrorism financing, fraud, cybercrimes, or other illicit activity.” Lastly, Reserve Banks are expected to confirm that institutions with master accounts have BSA/AML compliance programs with appropriate risk-based procedures for conducting ongoing customer due diligence, and designed to support compliance with the Office of Foreign Assets Control (OFAC) Regulations. The 2022 Guidelines have ranked Puerto Rico’s IFEs and IBEs as high-risk Tier 3 institutions. Tier 3 institutions are usually non-federally-insured, not supervised by a prudential federal banking agency, and subject to a weaker supervisory or regulatory framework than that applicable to federally insured institutions. Consequently, Tier 3 institutions undergo the strictest level of review and their access requests may require more extensive due diligence. A number of critics would prefer those Tier 3 institutions not be granted Fed access at all. In an April 2022 comments letter to the Guidelines, a group of banking associations including the American Bankers Association and the Clearing House Association LLC, told the Fed that non-federally insured applicants “pose serious risk that must be addressed in any evaluation process … [and] raise substantial and important threshold questions of whether Congress intended for such institutions to be legally eligible to apply for Reserve Bank accounts and services.” The Fed decided to forego making amendments to the Guidelines. In 2012, the FRBNY approved Banco de San Juan International Inc.’s (BSJI) application for a master account. By its own admission, BSJI was a small bank operating from a small single office in Puerto Rico. Its entire workforce consisted of 12 employees, and its 14-customer base was comprised of relatives of BSJI’s owner. Once opened, master accounts are governed by Master Account Agreements (“MAA”) and Operating Circulars that Reserve Banks may issue from time to time. MAAs contain explicit language giving a Reserve Bank the authority to terminate the account at any time. BSJI’s MAA granted the FRBNY that same authority. On April 24, 2023, after years of exchanging requests for information, missing reporting deadlines, concerns over BSJI’s undue risk of illicit activity, numerous communications and negotiations, requests for assessments attesting to the effectiveness of BSJI’s compliance program, opportunities to address deficiencies, a Supplemental Terms agreement, and account closure extensions, the FRBNY informed BSJI that it would be terminating its master account by June. The FRBNY’s decision was informed and approved by the Reserve Board. FRBNY’s April letter, and subsequent court filings, identify various controls deficiencies, including BSJI’s inability to address the high-risk nature of its transactional activity through a competent compliance program. Despite a reported multi-million-dollar investment in independent testing and compliance enhancements, the FRBNY found that BSJI never validated the enhancements, and that flagged program deficiencies had remained unaddressed for many months thereafter. BSJI’s recordkeeping was deficient and inconsistent despite large payments made to individuals; account information was missing; and explanations for suspicious wire transfer activity were frequently absent. BSJI relied on familial connections to justify the rapid funds movements, layering, and large inflows from shell companies in high-risk jurisdictions. The FRBNY noted that it was precisely the relatedness between the entity’s owner and its accountholders, as well as the absence of suspicious activity report filings, that evinced a lack of compliance independence and effectiveness. The FRBNY also found that BSJI’s repeated mention in negative media reports, undocumented screening of Politically Exposed Persons (PEPs), and ineffective sanctions screening, among others, contributed to its conclusion that BSJI had not met Principle 5 of the Guidelines. Last Summer, BSJI moved to enjoin the Fed’s decision to close its master account, calling it arbitrary, unlawful and in “violation of its statutory, Constitutional and contractual rights.” On October 27, 2023, the court disagreed with BSJI, finding that once granted, maintaining a master account is a privilege, not a right, and that the FRBNY’s decision was well documented and justified. BSJI has filed a notice of appeal. BSJI’s is not the first case where a court has had to examine master accounts within the Federal Reserve System. Previous and ongoing litigation has, for the most part, involved delays in the review and approval of access applications, and whether master accounts should be granted as a matter of right. BSJI’s case is distinguishable, however, in that the FRBNY terminated an existing account. Moreover, unlike other cases, FRBNY’s decision was based upon its interpretation of internal regulations regarding the undue risk posed to the Fed and the economy by BSJI’s numerous BSA/AML compliance deficiencies. These are some of the key takeaways from the court’s decision regarding BSJI’s master account: Puerto Rican IFEs and IBEs are at a disadvantage. Because of the island’s present regulatory framework and non-federal insurance protection, these institutions have been relegated to a third-tier position subject to the strictest level of review. The BSJI judge noted that the Office of the Commissioner of Financial Institutions (OCFI) has “severe resource constraints” and “few examiners and supervisory staff to effectuate its supervisory program”. Until the island’s Legislature equips OCFI with additional resources to carry out its regulatory obligations, IFE’s and IBEs should consider applying for membership to the Federal Reserve System, which would subject them to oversight and regulation by the Fed. Although Federal Reserve membership is neither a pre-requisite nor a guarantee that a master account will be granted, it would nonetheless demonstrate a willingness to submit to full federal supervision and accountability. Moreover, the membership may help elevate the institution to a first or second tier under the Guidelines.During the pendency of master account applications, the island’s international entities may want to consider pursuing corresponding banking relationships. These relationships, while costly, would introduce them to the U.S. banking system, establish good will, while enabling them to serve their clients and make a profit.State chartered institutions without federal insurance have limited federal oversight, hence the Tier 3 classification. Therefore, IFEs and IBEs that meet the criteria, could consider applying for FDIC insurance in order to appease any concerns the Fed may have regarding its ability to monitor or mitigate risk if an account is granted.Stay ahead of the Reserve Bank’s information gathering and reporting requirements. By law, IFEs and IBEs are expected to be in compliance with all relevant AML, payments, sanctions and risk management laws and regulatory requirements at both the state and federal level. Make every effort to meet filing and reporting deadlines, and respond to requests for information in a timely manner. Do not underestimate your regulator’s communication and cooperation with the Fed, other regulators, and law enforcement entities. Anticipate that your regional Reserve Bank will research and rely on adverse media reports to evaluate your admission and permanence within the Federal Reserve System. Be prepared to respond to negative media reports and where necessary, dispel any concerns about your institution’s transactional activity. If tipped about an upcoming report, consider self-reporting to your regional Reserve Bank.Once granted, envision how losing a master account will impact your institution and work towards maintaining it. Institutions who have judicially challenged the Fed have alleged that without a master account they are “nothing more than a vault,” “relegated to depend on intermediary institutions,” treated like “second class citizens,” or become exposed to additional risks and expenses. Remember, institutions that execute MAAs knowingly acquiesce to the FRBNY’s discretionary authority to terminate the relationship based on its interpretation of its authoritative statute, the Bank Secrecy Act, and its internal regulations. There is no statutory provision requiring that the Fed maintain an account relationship with an otherwise ineligible institution.Maintain an amicable relationship with your regional Reserve Bank. Rely on consultants who can independently and objectively evaluate and validate your internal controls for customer due diligence, and ensure the timely and appropriate review and disposition of suspicious activity alerts and case investigations.Heed the advice of independent consultants who review and validate your technology and compliance programs. Address identified red flags and do not postpone mending or validating your systems. PEP screening requires heightened review and documentation, and OFAC updates its sanctions lists almost on a daily basis. Therefore, in this day and age, neglecting an investment in human expertise and technological resources to screen and combat crime is unacceptable.Use your common sense. Transactions between related parties involving family members, friends, business associates or corporate entities can be suspicious and often present an increased fraud and money laundering risk. Therefore, failing to accurately investigate and document them in anticipation of reporting decisions is inexcusable. If the transactions flowing through your master account will draw the attention of your Reserve Bank and/or a regulator, be prepared to make the necessary adjustments, including de-risking, reassessing internal investigations, reducing your risk appetite, etc. In similar instances where, as with BSJI, the reasons for closure were historical, well-documented, and the institution was granted numerous opportunities to mend its ways, it is highly unlikely that a court will second guess the FRBNY’s interpretation of its Operation Circulars and Guidelines. It is also unlikely that a court will interject itself in the Fed’s finding that maintaining the account poses undue illicit and money laundering risks. Certainly, the court’s reference to a 2022 U.S. Department of the Treasury warning that IBEs and IFEs pose a high risk to the FRBNY because of their attraction as money laundering vehicles, and ability to facilitate illicit financial activity, did not help BSJI. The Fed is tasked with, among other things, supporting a healthy economy, promoting the stability of the U.S. financial system, and monitoring the impact that individual institutions will have on the financial system as a whole. Pursuing and maintaining a Federal Reserve master account is not to be taken lightly. Therefore, it is no surprise that much will be expected from Tier 3 institutions. IFEs and IBEs area creatures of the regulatory and oversight environment in the island. They may be misunderstood and unsupported by their banking peers. Yet, in spite of the opposition, the Fed has opted to welcome these non-traditional banking entities into its system and has now provided transparent guidelines to ensure permanence and success. From here on, it behooves these entities to engage within the banking system in a responsible way and thrive. Aixa Maldonado-Quinones is a Washington D.C. and New York Partner at Zeichner, Ellman & Krause LLP, where she counsels corporate clients, including financial institutions and their executives, on government and internal investigations, compliance, and White Collar crime issues.
Key Takeaways from Manhattan Federal Court’s Denial of Banco de San Juan International Inc.’s “Right” To A Master Account By Aixa Maldonado-Quinones | November 6, 2023 This article has been updated. Click here to view. Puerto Rico’s international financial and banking entities (“IFEs and IBEs”) rely on master accounts to access the Federal Reserve’s (“the Fed”) payments system and offer their foreign clientele check clearing, wire transfer, and automated clearing house services without the need for intermediary banks. The typical traditional bank application is reviewed and granted within days. But for non-traditional institutions, like island IFEs and IBEs, the master account application and approval process has become an arduous and painstaking one, fraught with uncertainty. Review delays, account suspensions, requests for information, and the uncertainty of termination has led to consternation and disincentivized investors from moving to the island. To date, ten Puerto Rican IFEs and IBEs have master account applications pending before the Federal Reserve Bank of New York (“FRBNY”), four of which have been pending since 2020. But for the resilient few who choose to stay and fight the fight there is hope – if you’re willing to do the work. A number of years back, several non-traditional banking entities (i.e., crypto asset custodians) questioned the policies behind the eligibility to a Fed master account. Knowing that its application and review process was burdened with lack of transparency and inconsistencies, in August 2022 the Federal Reserve Board published certain Guidelines for Evaluating Account and Services Requests to ensure that regional Reserve Banks evaluate a transparent and consistent set of risk-focused factors when reviewing account requests. The Guidelines include a tiered review framework to provide additional clarity on the level of due diligence and scrutiny that Reserve Banks should apply when reviewing access requests from different types of institutions. Reserve Banks are also required to consider six principles, the fifth of which (Principle 5) is whether providing the account and services would create “undue risk to the overall economy by facilitating activities such as money laundering, terrorism financing, fraud, cybercrimes, or other illicit activity.” Lastly, Reserve Banks are expected to confirm that institutions with master accounts have BSA/AML compliance programs with appropriate risk-based procedures for conducting ongoing customer due diligence, and designed to support compliance with the Office of Foreign Assets Control (OFAC) Regulations. The 2022 Guidelines have ranked Puerto Rico’s IFEs and IBEs as high-risk Tier 3 institutions. Tier 3 institutions are usually non-federally-insured, not supervised by a prudential federal banking agency, and subject to a weaker supervisory or regulatory framework than that applicable to federally insured institutions. Consequently, Tier 3 institutions undergo the strictest level of review and their access requests may require more extensive due diligence. A number of critics would prefer those Tier 3 institutions not be granted Fed access at all. In an April 2022 comments letter to the Guidelines, a group of banking associations including the American Bankers Association and the Clearing House Association LLC, told the Fed that non-federally insured applicants “pose serious risk that must be addressed in any evaluation process … [and] raise substantial and important threshold questions of whether Congress intended for such institutions to be legally eligible to apply for Reserve Bank accounts and services.” The Fed decided to forego making amendments to the Guidelines. In 2012, the FRBNY approved Banco de San Juan International Inc.’s (BSJI) application for a master account. By its own admission, BSJI was a small bank operating from a small single office in Puerto Rico. Its entire workforce consisted of 12 employees, and its 14-customer base was comprised of relatives of BSJI’s owner. Once opened, master accounts are governed by Master Account Agreements (“MAA”) and Operating Circulars that Reserve Banks may issue from time to time. MAAs contain explicit language giving a Reserve Bank the authority to terminate the account at any time. BSJI’s MAA granted the FRBNY that same authority. On April 24, 2023, after years of exchanging requests for information, missing reporting deadlines, concerns over BSJI’s undue risk of illicit activity, numerous communications and negotiations, requests for assessments attesting to the effectiveness of BSJI’s compliance program, opportunities to address deficiencies, a Supplemental Terms agreement, and account closure extensions, the FRBNY informed BSJI that it would be terminating its master account by June. The FRBNY’s decision was informed and approved by the Reserve Board. FRBNY’s April letter, and subsequent court filings, identify various controls deficiencies, including BSJI’s inability to address the high-risk nature of its transactional activity through a competent compliance program. Despite a reported multi-million-dollar investment in independent testing and compliance enhancements, the FRBNY found that BSJI never validated the enhancements, and that flagged program deficiencies had remained unaddressed for many months thereafter. BSJI’s recordkeeping was deficient and inconsistent despite large payments made to individuals; account information was missing; and explanations for suspicious wire transfer activity were frequently absent. BSJI relied on familial connections to justify the rapid funds movements, layering, and large inflows from shell companies in high-risk jurisdictions. The FRBNY noted that it was precisely the relatedness between the entity’s owner and its accountholders, as well as the absence of suspicious activity report filings, that evinced a lack of compliance independence and effectiveness. The FRBNY also found that BSJI’s repeated mention in negative media reports, undocumented screening of Politically Exposed Persons (PEPs), and ineffective sanctions screening, among others, contributed to its conclusion that BSJI had not met Principle 5 of the Guidelines. Last Summer, BSJI moved to enjoin the Fed’s decision to close its master account, calling it arbitrary, unlawful and in “violation of its statutory, Constitutional and contractual rights.” On October 27, 2023, the court disagreed with BSJI, finding that once granted, maintaining a master account is a privilege, not a right, and that the FRBNY’s decision was well documented and justified. BSJI has filed a notice of appeal. BSJI’s is not the first case where a court has had to examine master accounts within the Federal Reserve System. Previous and ongoing litigation has, for the most part, involved delays in the review and approval of access applications, and whether master accounts should be granted as a matter of right. BSJI’s case is distinguishable, however, in that the FRBNY terminated an existing account. Moreover, unlike other cases, FRBNY’s decision was based upon its interpretation of internal regulations regarding the undue risk posed to the Fed and the economy by BSJI’s numerous BSA/AML compliance deficiencies. These are some of the key takeaways from the court’s decision regarding BSJI’s master account: Puerto Rican IFEs and IBEs are at a disadvantage. Because of the island’s present regulatory framework and non-federal insurance protection, these institutions have been relegated to a third-tier position subject to the strictest level of review. The BSJI judge noted that the Office of the Commissioner of Financial Institutions (OCFI) has “severe resource constraints” and “few examiners and supervisory staff to effectuate its supervisory program”. Until the island’s Legislature equips OCFI with additional resources to carry out its regulatory obligations, IFE’s and IBEs should consider applying for membership to the Federal Reserve System, which would subject them to oversight and regulation by the Fed. Although Federal Reserve membership is neither a pre-requisite nor a guarantee that a master account will be granted, it would nonetheless demonstrate a willingness to submit to full federal supervision and accountability. Moreover, the membership may help elevate the institution to a first or second tier under the Guidelines.During the pendency of master account applications, the island’s international entities may want to consider pursuing corresponding banking relationships. These relationships, while costly, would introduce them to the U.S. banking system, establish good will, while enabling them to serve their clients and make a profit.State chartered institutions without federal insurance have limited federal oversight, hence the Tier 3 classification. Therefore, IFEs and IBEs that meet the criteria, could consider applying for FDIC insurance in order to appease any concerns the Fed may have regarding its ability to monitor or mitigate risk if an account is granted.Stay ahead of the Reserve Bank’s information gathering and reporting requirements. By law, IFEs and IBEs are expected to be in compliance with all relevant AML, payments, sanctions and risk management laws and regulatory requirements at both the state and federal level. Make every effort to meet filing and reporting deadlines, and respond to requests for information in a timely manner. Do not underestimate your regulator’s communication and cooperation with the Fed, other regulators, and law enforcement entities. Anticipate that your regional Reserve Bank will research and rely on adverse media reports to evaluate your admission and permanence within the Federal Reserve System. Be prepared to respond to negative media reports and where necessary, dispel any concerns about your institution’s transactional activity. If tipped about an upcoming report, consider self-reporting to your regional Reserve Bank.Once granted, envision how losing a master account will impact your institution and work towards maintaining it. Institutions who have judicially challenged the Fed have alleged that without a master account they are “nothing more than a vault,” “relegated to depend on intermediary institutions,” treated like “second class citizens,” or become exposed to additional risks and expenses. Remember, institutions that execute MAAs knowingly acquiesce to the FRBNY’s discretionary authority to terminate the relationship based on its interpretation of its authoritative statute, the Bank Secrecy Act, and its internal regulations. There is no statutory provision requiring that the Fed maintain an account relationship with an otherwise ineligible institution.Maintain an amicable relationship with your regional Reserve Bank. Rely on consultants who can independently and objectively evaluate and validate your internal controls for customer due diligence, and ensure the timely and appropriate review and disposition of suspicious activity alerts and case investigations.Heed the advice of independent consultants who review and validate your technology and compliance programs. Address identified red flags and do not postpone mending or validating your systems. PEP screening requires heightened review and documentation, and OFAC updates its sanctions lists almost on a daily basis. Therefore, in this day and age, neglecting an investment in human expertise and technological resources to screen and combat crime is unacceptable.Use your common sense. Transactions between related parties involving family members, friends, business associates or corporate entities can be suspicious and often present an increased fraud and money laundering risk. Therefore, failing to accurately investigate and document them in anticipation of reporting decisions is inexcusable. If the transactions flowing through your master account will draw the attention of your Reserve Bank and/or a regulator, be prepared to make the necessary adjustments, including de-risking, reassessing internal investigations, reducing your risk appetite, etc. In similar instances where, as with BSJI, the reasons for closure were historical, well-documented, and the institution was granted numerous opportunities to mend its ways, it is highly unlikely that a court will second guess the FRBNY’s interpretation of its Operation Circulars and Guidelines. It is also unlikely that a court will interject itself in the Fed’s finding that maintaining the account poses undue illicit and money laundering risks. Certainly, the court’s reference to a 2022 U.S. Department of the Treasury warning that IBEs and IFEs pose a high risk to the FRBNY because of their attraction as money laundering vehicles, and ability to facilitate illicit financial activity, did not help BSJI. The Fed is tasked with, among other things, supporting a healthy economy, promoting the stability of the U.S. financial system, and monitoring the impact that individual institutions will have on the financial system as a whole. Pursuing and maintaining a Federal Reserve master account is not to be taken lightly. Therefore, it is no surprise that much will be expected from Tier 3 institutions. IFEs and IBEs area creatures of the regulatory and oversight environment in the island. They may be misunderstood and unsupported by their banking peers. Yet, in spite of the opposition, the Fed has opted to welcome these non-traditional banking entities into its system and has now provided transparent guidelines to ensure permanence and success. From here on, it behooves these entities to engage within the banking system in a responsible way and thrive. Aixa Maldonado-Quinones is a Washington D.C. and New York Partner at Zeichner, Ellman & Krause LLP, where she counsels corporate clients, including financial institutions and their executives, on government and internal investigations, compliance, and White Collar crime issues.