U.S. broker-dealers scrutinized for anti-laundering compliance in Venezuelan currency swaps

November 13, 2012

By Brett Wolf

NEW YORK, Nov. 13 (Thomson Reuters Accelus) – Securities industry regulators are beginning to ask U.S. broker-dealers tough questions about how they are mitigating money laundering and sanctions risks associated with their involvement in a 2-year-old currency exchange system run by the Venezuelan government, sources familiar with the issue said.

“There are a lot of questions being asked by regulators and compliance officers,” said Sven Stumbauer, managing director of Veris Consulting Inc’s Miami office. “And some broker-dealers, especially small introducing brokers, cannot answer them.”

“Now people are looking at it and saying ‘Do we really understand the business and is there exposure for both money laundering and sanctions?'”

Buying large sums of U.S. dollars in Venezuela is not simple due to strict currency restrictions. The complex system that many importers in the South American country rely on to meet their need for American currency poses money-laundering and sanctions risks for the U.S. broker-dealers that facilitate it, anti-money laundering officers and consultants said.

For Venezuelans adverse to buying large sums of U.S. dollars illegally on street corners or who lack business associates with dollars in U.S. accounts, there are two legal ways to exchange Venezuelan bolivars for U.S. dollars.

The first is to buy dollars through the government’s currency exchange agency, the Comision de Administracion de Divisas (CADIVI). That option often is impractical because CADIVI, which seeks to limit capital flight, makes only a small sum of foreign currency available and its dealings involve a slow process filled with red tape, the sources said.

How SITME works

The other option is the Sistema de Transacciones en Moneda Extranjera (SITME), a system involving U.S. dollar-denominated bonds generally issued by Petroleos de Venezuela (PDVSA), a state owned oil company, and sold to the Banco Central de Venezuela (BCV), the country’s central bank.

The BCV then distributes the bonds to top-tier banks in Venezuela, which act as custodians. When bank customers want to use local currency to buy U.S. dollars the banks deposit PDVSA bonds with U.S. broker-dealers for sale. The proceeds are then wired to a U.S. dollar account belonging to the Venezuelan bank on behalf of the Venezuelan importers.

Businesses in Venezuela can buy up to $350,000 per month via SITME. But because the Venezuelan banks bundle SITME bonds linked to various customers, it is not unusual for a bank to deposit millions of dollars worth of bonds with a U.S. broker-dealer each month.

Because the overall volume of SITME transactions totals several billion dollars a year, they can be highly profitable for U.S. broker-dealers due to the commissions or mark-ups they are able to charge.

However, there are sometimes overlooked money laundering and sanctions risks that accompany these transactions – such as the risk of facilitating currency swaps illegal under Venezuelan laws aimed at curbing flight capital or conducted for the benefit of a drug trafficker or blacklisted Iranian party — that must be mitigated, Stumbauer said.

Anti-money laundering officers at a large U.S. broker-dealer told Compliance Complete that while it is unclear whether firms have an obligation to report suspected efforts to evade Venezuelan currency restrictions to U.S. authorities, their firm does so out of an abundance of caution.

They added that immediately before and after the October reelection of Venezuelan President Hugo Chavez there was a surge in demand for U.S. dollars and resulting PDVSA bond sales, a development that appeared to catch U.S. securities regulators off guard.

Regulators take notice

A spokeswoman for the Financial Industry Regulatory Authority (FINRA) told Compliance Complete the the self-regulatory organization is probing whether broker-dealers are meeting their anti-money laundering obligations when dealing the Venezuelan bonds.

“With respect to SITME and other similar transactions, we are reviewing whether firms are complying with applicable FINRA and federal rules and regulations,” she said.

The anti-money laundering compliance officers said their firm recently received a “sweep” letter from FINRA in which it inquired about the volume of PDVSA bonds their firm was handling. They said it appeared that FINRA, which had informally discussed SITME with anti-money laundering professionals in the past, had begun taking the issue more seriously and circulated the letter to determine which broker-dealers were doing large amounts of the business so they would know whose compliance regimes to review.

When asked how the Securities and Exchange Commission perceives the money laundering and sanctions risks associated with SITME, a spokesman for the regulator declined to comment.

Justice Department also interested

The U.S. Justice Department in the past took interest in another Venezuelan bond-based currency system known as permuta, a now-defunct scheme that was run by Venezuelan broker-dealers rather than the government but in many ways mirrored SITME.

In 2009, federal prosecutors brought money laundering charges against Rama Vyasulu, the owner of the Miami-based Rosemont Finance Corporation, which specialized in facilitating permuta transactions. Vyasulu ultimately pleaded guilty, admitting he “laundered” drug money for undercover federal agents.

As part of the Justice Department probe of Vyasulu’s permuta-linked activity, it seized more than $150 million held in 60 Bank of America accounts. Those seizures caused the permuta to temporarily grind to a halt.

Some believe the Rosemont case, which sources say prompted some broker-dealers to report related suspicious transactions to the U.S. Treasury Department, played a key role in the Venezuelan government’s decision to outlaw the permuta and implement SITME in June 2010.

As Stumbauer put it, the Venezuelan government’s goal was to replace the Venezuelan broker-dealers as the middleman in the transactions to better enforce strict limits on currency exchange.

He added that the Venezuelan government knew that because CADIVI does not provide enough liquidity for the business community, a system such as SITME was necessary to prevent pushing currency exchange to the black market.

SITME participation

In order to participate in SITME, both Venezuelan banks and their customers must be approved by Venezuelan regulators.

While the CADIVI system has traditionally been seen as a realistic option only for well-connected people, SITME is accessible to anyone with enough money, Stumbauer said.

“With SITME, Joe off the street can come in and go through the approval process,” he said.

He added, however, that because of limits on the number of PDVSA bonds that are issued for the program, “just because you registered through SITME and you’ve been a customer of your Venezuelan bank for 90 days does not necessarily mean you are going to obtain dollars, because otherwise it would be a freely floating exchange rate.”

Stumbauer said the banks are allotted a certain number of bonds that generally go to “preferred customers” such as long-term customers or those willing to bring other business to the bank.

“For those customers, there’s a pretty good chance when you need U.S. dollars, within the limits set by SIFME, you’re going to obtain them,” he said.

The risks

Stumbauer said a U.S. broker-dealer involved in SITME transactions may receive millions of dollars worth of bonds from a Venezuelan bank but the broker-dealer does not know who the bank’s underlying customers are.

“Is it one customer? Is it ten customers?” he said.

He added that because SITME involves the use of securities accounts for transactions that lack an investment purpose — a red flag for money laundering or other criminal activity — they are of particular interest to regulators.

From an anti-money laundering perspective, U.S. broker-dealers are required to take a risk-based approach when determining the amount of due diligence they need to conduct on customers, Stumbauer said.

Because foreign financial institutions are considered high-risk customers, enhanced due diligence requirements imposed by the USA Patriot Act apply. A broker-dealer must take additional steps to ensure it knows who it is doing business with, he said.

“When a regulator asks you what you know about ‘Banco A,’ and you say ‘Well, it’s duly licensed and it’s authorized to participate in SITME transactions and there is no negative news about it,’ is this going to satisfy the regulator? Probably not,” Stumbauer said. “At one point you need to demonstrate to regulators that you did adequate due diligence.”

He said this cannot be accomplished effectively “from afar” through certifications and questionnaires, but requires close inspection, or “looking under the hood and kicking the tires.”

Before U.S. broker-dealers start doing SITME business they need to fly to Venezuela and conduct on-site reviews of banks’ anti-money laundering controls and ensure they are screening against the U.S. sanctions blacklist maintained by Treasury’s Office of Foreign Assets Control (OFAC), said Stumbauer, who has undertaken a number of these fact-finding trips on behalf of clients.

Stumbauer said the broker-dealers also must gain an understanding of the Venezuelan banks’ customer bases.

“Who are the actual customers in Venezuela that are transacting all those SITME bonds? Do you want to be associated with them and are they on the OFAC list?” he said, noting that sanctions risks are particularly high because Venezuela has close economic ties to Iran.

OFAC administers the U.S. sanctions program and fines financial institutions and other businesses that run afoul of its rules. In recent years it has partnered with the Justice Department and New York authorities to penalize financial institutions that processed transactions for Iranians and other sanctioned parties to the tune of more than $2 billion.

Stumbauer added that the broker-dealer should also determine whether any of the bank’s board members are Venezuelan officials, or whether the government is a passive shareholder. If so, he said there will generally need to be an analysis of exposure to Politically Exposed Persons (PEPs) — officials and their associates considered to pose heightened risk of corruption and related money laundering.

“Do we actually have SITME transactions with PEPs? How much and is this reasonable?” he said.

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus (http://accelus.thomsonreuters.com/) . Compliance Complete (http://accelus.thomsonreuters.com/solutions/regulatory-intelligence/compliance-complete/) provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges. Follow Accelus compliance news on Twitter at: http://twitter.com/GRC_Accelus )

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Excellent article. There are a lot of International Bank Entities in Puerto Rico that receive funds from Venezuelan customers once the Bonds are swapped. The role of their Compliance Officer is to mitigate the risk associated with BSA/AML, however the risk in the Bond Swap process includes unknown originator of the funds, which clearly has exposure to money laundering, corruption and/or terrorist financing.

I think that you should write an article regarding the actual illegal ways to exchange Venezuelan bolivars for U.S. dollars with the intention of teaching the bankers how to mitigate the risk associated to money laundering.

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