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Risk Based Approach
Zooming toward Regulator Enforcement!
Emerging compliance issues in the COVID-19 “work from home” era era.
Author: Gerry McGeachy, C.S., CAMS, CFCS, CFE, FIP
Quick Takeaways for regulated organizations who need to invoke a modified compliance program to address the current pandemic situation:
- Take steps to formally employ a risk based approach to the new expanded “work from home” reality;
- Generate clear documentation surrounding the risk assessment, options, decisions and implementation;
- Engage in education and training specifically related to the use of additional communication tools when working from home;
- Integrate your changes and decisions into the formal organization Code of Conduct and business level guidance and policy;
- Demonstrate support from senior management by having the right decision-makers involved and by allocating appropriate funding for the implementation of the decisions made;
- Ensure clear lines of communication with senior management regarding the decisions, and strive for a unified organizational approach;
- Generate appropriate metrics for evaluation and use them to refine the approach;
- Prepare now for questions from regulators and litigation through smart information governance, classification of documents and create a record that defends your organization’s decisions and actions.
Have you ever heard the saying “when the cat is away, the mice will play?” These days to a large degree both the cat and the mice are away, working from home and not subject to the usual compliance supervision, monitoring and surveillance. For the most part everyone is getting their work done admirably, managing the pressures of home life and their work day. If you operate in a regulated industry, are you taking steps to ensure that “work from home” is covered by an effective compliance regime?
“…having investigated Canadian banks, and other business entities involved in financial transactions in Canada and internationally, I am convinced that the human factor is the one of the largest areas of ongoing vulnerability… and the most likely to generate a regulatory sanction.”
Employees are now able to be on their home phones or their personal cellphones, sitting at a desk with their personal computer alongside their work computer, with access to any sort of third-party communication tool that they should choose to utilize. Without creative thinking and controls, there is no compliance presence, at least in the human, personal sense.
The exodus of personnel from the business office to their home locations is a significant regulatory compliance issue. As I set out herein, one of the greatest concerns and dangers that needs to be managed is the ready availability of additional third-party communication tools in an unmonitored environment. Having prosecuted many cases involving financial crime and having investigated Canadian banks, and other business entities involved in financial transactions in Canada and internationally, I am convinced that the human factor is the one of the largest areas of ongoing vulnerability. It is the hardest area to manage and the most likely to generate a regulatory sanction.
In addition to being a crown attorney and prosecutor for many years I was one of the senior litigation counsel in the enforcement branch at the Ontario Securities Commission in 2018 and 2019. At the OSC I was an investigator into companies that range from large international banks all the way down to small internet-based companies offering financial services.
One of the investigations I participated in as senior litigation counsel with the OSC involved Canadian bank foreign exchange traders’ internal and external electronic communication. This investigation resulted in a settlement by TD Bank and the Royal Bank of Canada. The allegations and settlement revolved around a failure to have sufficient supervision and controls in place and insufficient promotion of a culture of compliance. It was agreed ultimately that these failings put customers at risk of harm, could undermine market integrity and were contrary to the public interest.
The world of financial institutions and related businesses seems vast at first glance but it makes sense to break it down into smaller functional groups where specific people have specialized skill sets. The business activities are often performed by people who move around from institution to institution over the course of their career. This results in ongoing relationships which are healthy and great for business, and enable people to get things done. But it also means that your personnel have old friends and trusted contacts who work for, or even own, other businesses. This reality exposes your customers to risk. In areas of operation such as OTC transactions, options, “M&A”, or other areas where salespeople, financial advisors, dealers, brokers and traders who make deals are in a position to share critical confidential deal information with external third parties, the risk is heightened. There may be temptation for individuals or groups to benefit through collusive or manipulative behaviour.
This quick blog article does not delve at length into the larger misconduct issues. This article is mainly about a particular vulnerability that has grown vastly in scale since the arrival of “social distancing” and the overall COVID-19 pandemic response - the availability of unmonitored third-party communication tools (i.e. - Zoom, Viber, Telegram, Signal, Houseparty, WeChat, Line, Pryvate Now, Wickr… and the list goes on. Some are specifically designed to ensure encryption and anonymity and are marketed as such).
“…These days … both the cat and the mice are away, working from home and not subject to the usual monitoring and surveillance…”
Right now regulators (appropriately) recognize the severity of the COVID-19 situation and many are relaxing a number of procedural requirements. Things like deadlines and methods of reporting are being modified for the near future but the ultimate obligations regarding substantive regulatory requirements are generally not being modified. For example, the Ontario Securities Commission has published what it has described as temporary blanket relief from deadlines for filing and FINTRAC has required that reporting entities submit a “voluntary self-declaration of non-compliance” which will be “taken into account in future compliance activities”.
This means that when regulators finally catch their breath and begin to look back to consider early to mid-2020, they may have questions for you. Months from now, when things will have (presumably and hopefully) returned to a more normal state, regulators may still be prepared to overlook lapses in some timelines, failure to meet specific date requirements and irregularities in how information was reported. One important way of dealing with a true inability to comply with a deadline is to notify the regulator of the failure, preferably before it happens, provide the reason and confirm that it is documented and provide a plan to address the issue as soon as possible. That will help somewhat with a due date for filing a document, but substantive failures which reflect true regulatory failings are unlikely to get a pass. For true substantive violations where the required level of diligence cannot be established, it is more likely that the COVID-19 pandemic response will translate into a reduction in overall penalty or other sanction, if the error was in good faith. It is worth noting that a reduced regulatory penalty does not necessarily translate into a reduction in reputational harm in the eyes of the public or the capital markets community.
The “Work from Home” Change Brought About by COVID-19
There are numerous developments taking place as a result of COVID-19 but one of the greatest is that vast numbers of workers are now operating out of their own homes, and not coming into the office.
Is your organization ready to:
- Take steps to ensure that your “work from home” employees are not engaged in misconduct at home that affects your business?;
- Defensibly capture and document the development of your in-house compliance approach to the new reality such that you will be able to satisfy your regulators that you have done a sufficient job?;
(This latter point (ii) is not about factually doing good a good job. It is about the equally important task of generating a defensible evidentiary record that can be produced on demand to demonstrate to a regulator that there is no need for an investigation or enforcement proceeding. You have to comply. You also have to be able to show that you complied.)
“…You have to comply. You also have to be able to show that you complied.”
People are Great – They are also a Great Source of Vulnerability
Human skill, creativity, motivation, experience, relationships and intelligence underly all successful business operations. But some of the problems with humans within a regulated organization include that they:
- occasionally make mistakes;
- have limited capacity to remember and process large data sets;
- are often ambitious;
- can at times be lazy or procrastinate;
- rationalize when confronted with a choice between ethics/compliance and self-interest;
- can be wilfully dishonest, sometimes in creative and unpredictable ways.
In order to adequately assess what is required and to ensure that the “work from home” reality is addressed we should look to current best practices including:
- establishing an overall risk appetite for the organization and for business units;
- “Tone from the Top”;
- education and training;
- global and departmental codes of conduct;
- whistleblower programs;
- appropriate compensation structure;
- training and awareness about the presence of surveillance and monitoring;
- deterrent practices including appropriate sanctions for misconduct ranging from education to dismissal.
These are all applicable and important during the rapid shift to “work from home” that is required to address COVID-19.
There are “carrots” and “sticks” built into these practices. Some are intended to encourage and push people toward the right behaviours. Appropriate compensation structure falls into this category, particularly if compliance behaviours are factored into decisions surrounding compensation and career advancement.
Some of the practices are intended to identify misconduct and punish. A number of them have a blended effect. Surveillance and monitoring is a “stick” because it catches misconduct and facilitates on enforcement step. But additionally, widespread distribution of information about the existence of surveillance and monitoring or a whistleblower program encourages appropriate behaviour. It encourages those who would apply a cost vs. benefit approach to misconduct to attach greater costs to misconduct due to the increased likelihood of being caught. This makes misconduct appear less attractive to those types of individuals.
Negative financial or reputational harm often flows from honest human error (often caused by sloppiness or curiosity) such as in the case of phishing type attacks and those involving human engineering. But there is also human dishonesty, fraud and corruption to address. We know from experience that there is a risk that some misconduct may be tolerated by senior management if the bad actor generates enough profit, or if the behaviour can be rationalized into a dubious form of acceptance or even wilful blindness.
And then there are organizations where people openly behave unethically because that is “what you have to do”.
At the current time, there is a huge looming compliance risk for regulated financial sector businesses arising out of the massive changes and the “work from home” status of such a large number of employees. In addition to the number of employees, there are a number of roles that would not traditionally have been amenable to “work from home”. Regardless of the role of the personnel, the goal should be to modify compliance practices and procedures in order to ensure a reasonably similar level of oversight. Are you managing to enable the same level of monitoring and surveillance of personnel working from home? Are they sitting in their home office using their home computer on their desk alongside their work computer? Would this have been permitted if they were working in-house?
It is equally as important to consider whether the “work from home” employee has the appropriate resources in the home environment. If not, then effors should be made to ensure that the right tools are available to do the job. For example, a front line employee who conducts new account onboarding and CDD should have access to the same information remotely as they would have in the office. This includes sanctions checks, negative news, proprietary and open source tools.
Additionally, there are unique features of current COVID-19 transition/attempts to get people working in a socially distant way. It happened so quickly and without the usual planning or implementation of controls and performance indicators that undoubtedly compliance gaps have arisen. Of course, this change has been out of necessity. Businesses are being forced to get work done in a very different way using different communication tools and in a less monitored and surveilled environment, on a quicker timeline than they have been implemented after careful consideration of all the risks associated with this change.
“…Regardless of the role of the personnel, the goal should be to modify compliance practices and procedures in order to ensure a reasonably similar level of oversight.”
How are you going to address employees who are now able to use third-party communication channels to communicate in an unmonitored way? Are you allowing new communication tools to be installed on work devices during this period of change? Have they been properly evaluated not only through a privacy and data security lens, but also from a surveillance perspective. Can all the communications be ingested into your existing monitoring system? There is a considerable risk that senior management or business unit managers are taking steps, again out of a sense of necessity, to enable third-party “off the book” communication tools such as Zoom or other chat type tools for off-site employees.
This effectively eliminates the ability of any electronic transaction monitoring system to capture communications with third parties. Even if the installation of software on a “work device” is not permitted, people are now operating out of less secure locations. It is simply not possible to have compliance personnel or business unit compliance people visit with everyone in their home office or be present and visible and in a position to observe and make inquiry. Perhaps even more importantly, there may be a sense that they’re not as available to mentor and assist personnel with issues requiring clarification or interpretation. The essential message is that companies need to employ the full range of compliance program thinking to the new “work from home” reality. At its core is a risk based approach, enabling resources and thinking to be applied efficiently and proportionally to the most realistic and probable threats.
Graydon McGeachy Law LLP would be pleased to discuss how we can help you address any of your regulatory concerns. Before moving to private practice in 2019, Gerry McGeachy was a crown attorney in Ontario for 15 years, worked at a national law firm on matters for institutional clients and was a senior litigation counsel at the Ontario Securities Commission – Enforcement Branch. He understands evidence and government investigations.
Do the right thing and be able to demonstrate that you did the right thing. Although closely related, these are different issues, and they are both vital to preventing adverse consequences premised on an alleged failure to comply with a regulatory obligation.
All complex compliance functions are necessarily risk based when done correctly. This ensures that the right resources are applied to the right risk, thereby maximising mitigation and addressing the problem, not perfectly, but all things considered, in the best way that can be realistically accomplished. To seek to address complex compliance issues without a risk based approach in 2019 is like pouring money into the purchase of lottery tickets, hoping there will be a (highly unlikely) good outcome. That is not compliance, and it is not good corporate governance.
The resources need to be targeted to be effective. Currently, it is still people (aided by teams, processes and technology) who make those decisions, using the best information they have at their disposal.
Part of the perennial problem from the perspective of a financial institution or other reporting entity is the fear that a regulator, a court or even a party to litigation, will disagree with your risk assessment. If they are right… and you are wrong… then your resources have been misapplied, resulting in a less than optimal approach. Sanctions, damage awards and other detrimental outcomes will often be the result. Not to mention the fact that criminals are more likely to reap the financial benefits of their crime due to a deficient risk based approach. This includes drug dealers, human traffickers and fraudsters. Not a desirable outcome, and hence the importance of an effective risk based approach.
Arguably, there is no perfect risk assessment. One can argue about whether a risk assessment is perfect as long as it is procedurally and conceptually correct, regardless of its effect. But for the purpose of this brief blog post, let’s approach risk assessment from the perspective that if it is reasonable it is sufficient. I am not oversimplifying, just analytically setting the groundwork for highlighting the defensibility risk and distinguishing it from the risk based approach.
Let's use anti-money laundering (AML) compliance for example. For AML work, there is a lot built up in the concept of reasonableness including but not limited to:
- the designation of a CAMLO;
- tone from the top (corporate buy-in);
- appropriate use of technology;
- training and education;
- lines of reporting;
- credible internal enforcement and sanctions for deficiencies or misconduct;
- relationship between the business line, compliance and audit.
So let’s assume all these things (and more) are in place and the risk assessment that has been put in place is reasonable.
The question that is not asked often enough, and when asked, is not addressed frankly and starkly is:
Is our AML program defensible?
This question is not as important to a regulator because regulators are concerned with whether you complied, not how well you defend your view that you are complying. If they form the opinion that a program is insufficient they seek to enforce. It is grist for the mill.
If the entity cannot defend its program (usually a specific allegation but the allegation may be broad and extend as far "breach of industry standards" or a "failure to comply with an institutional Global Code of Conduct"), various findings may occur. It may be found to be eligible for an administrative monetary penalty due to a deficiency or perhaps to have violated a law such as securities law, or to have behaved contrary to the public interest.
It may seem strange, but although a finding of deficiency, once appeal routes are exhausted, is legally determinative, the finding doesn’t necessarily mean your program was or is substantively deficient. If your program was substantively sufficient, the negative outcome means you didn't have (and perhaps still don't collect) the evidence to defend it.
For the purpose of this blog post, let’s leave aside criminal or quasi-criminal offences which are determined on the standard of beyond a reasonable doubt and also the issue of settlement (based on its own sort of risk assessment). In standard regulatory litigation, a finding of deficiency occurs when a tribunal or court finds that the allegations are probably true. This may sound foreign to some readers who are not experienced in litigation, but essentially if a tribunal or court finds, after considering all the evidence, that an entity is 49% likely to be compliant then they must find the entity to be non-compliant.
Certainly, some deficiencies are clear, such as failing to file a report. In that case, the deficiency that is found overlaps with and maps perfectly onto the actual deficiency.
But what about situations where a program is in theory sufficient, but is not demonstrably so? This problem arises out of a lack of evidence - a failure of defensibility. It can apply to any poorly documented aspect of a compliance program. How would your senior compliance management team answer the question: How was your electronic monitoring tool calibrated, what types of inputs and transactional information was it capable of ingesting, and what factors were in place to generate a compliance “hit” in February 2016? (I know, it is more than one question but I hope you get the point). How about the follow up questions? (and keep in mind that all these questions may relate to a specific point in time):
- Who reviewed hits? Did they review all the hits and if not how were they selected?
- Was this system “out of the box” from the vendor or was it specifically tuned?
- Did you ever modify the tool to reduce positive hits? When, how and why?
- What qualifications and training did the reviewers have?
- How were concerns escalated from the initial reviewers?
- Did the compliance personnel in the second line of defence understand the subject matter of the “hit” or did they need to resort to asking the business line questions about the “hit”?
These are just a few questions on a specific topic related to electronic monitoring. There may be hundreds of questions that could be asked about this very specific issue for a very specific time. And there are obviously many other issues that may generate questions. Again, using AML as an example, topics may include the substantive issue of whether your human beings and/or electronic tools understood (for example) money-laundering typologies.
I have written about this elsewhere but since June 2019, the ability of staff and electronic tools to recognize indicia of money-laundering is very much in question. The substantive offence changed significantly to include the mental element of “recklessness”.
All that being said, the defensibility problem seems to me to be most likely to occur in a serious way when the human experience and judgment involved in risk assessment is not adequately documented. The activity of risk assessment, whether it is performed by an individual decision-maker in a small entity or a team project with numerous departments and data sources providing input to a risk committee, is the foundation of the risk based approach.
As long as best practices are in place and experienced, credible decision-makers are in the appropriate roles armed with the right information, their risk assessment should be defensible. Day to day, entities are focused not on defensibility but on effectiveness of their compliance program. Defensibility is a disturbing notion to some because it may seem like CYA (“cover your ass”) for a deficient program.
It is not that at all. Appropriate corporate governance not only entitles but arguably requires senior management to protect the organization by ensuring that the entity is in a position to rebut false claims by third parties that they are failing, whether it is in the regulatory or any other area of operation.
Spend time thinking about evidence and put your organization in the best position to show that you are doing the right thing. When responding to an allegation that you have failed, being able to demonstrate compliance may be just as important as actually having been compliant.
You've Probably Been Doing AML "Wrong" Since June 2019.
In June 2019 the Criminal Code of Canada was revised. Among many recent changes to the Code, the substantive offence of money-laundering was amended to add the mental element of recklessness.
Section 462.31 of the Code used to read:
Laundering proceeds of crime
462.31 (1) Every one commits an offence who uses, transfers the possession of, sends or delivers to any person or place, transports, transmits, alters, disposes of or otherwise deals with, in any manner and by any means, any property or any proceeds of any property with intent to conceal or convert that property or those proceeds, knowing or believing that all or a part of that property or of those proceeds was obtained or derived directly or indirectly as a result of
(a) the commission in Canada of a designated offence; or
(b) an act or omission anywhere that, if it had occurred in Canada, would have constituted a designated offence.
The section now reads:
Laundering proceeds of crime
462.31 (1) Every one commits an offence who uses, transfers the possession of, sends or delivers to any person or place, transports, transmits, alters, disposes of or otherwise deals with, in any manner and by any means, any property or any proceeds of any property with intent to conceal or convert that property or those proceeds, knowing or believing that, or being reckless as to whether, all or a part of that property or of those proceeds was obtained or derived directly or indirectly as a result of
(a) the commission in Canada of a designated offence; or
(b) an act or omission anywhere that, if it had occurred in Canada, would have constituted a designated offence.
This section is the bedrock of all AML work in Canada. It is the core measure against which suspicious transactions are measured. Of course, evidence of other offences should generate an STR too, but any transaction involving, for example, fraud, would also generate a money laundering concern. It is difficult to imagine a distinct substantive crime such as fraud which would not generate at least a suspicion that the party is dealing with in any manner or means, any property or any proceeds of any property with the requisite mental element of knowledge or belief. All financial crime is suspicious and at the same time all or nearly all transactions involving proceeds of financial crime are potentially money laundering.
The former pre-June 2019 AML offence, without the expanded mental element of recklessness has been the focus of AML monitoring, reporting, and training programs in Canada. This is no longer sufficient. In addition to the wide variety of recent changes coming to the FINTRAC regime and the Proceeds of Crime (Money Laundering) and Terrorist Financing Act and Regulations, organizations must grapple with a broader money laundering offence.
It is generally accepted that mere negligence is not recklessness. Something more is required. It has been described by the Supreme Court of Canada in R. v. Theroux as:
"Recklessness presupposes knowledge of the likelihood of the prohibited consequences. It is established when it is shown that the accused, with such knowledge, commits acts which may bring about these prohibited consequences, while being reckless as to whether or not they ensue."
Consider the example of a lawyer who regularly deposits money received from her client into her trust account. Under the prior money laundering offence, if the lawyer has no knowledge about an illicit source of the funds and has no reason to believe that the funds are proceeds of crime then the lawyer is not committing the crime of money laundering. It remains to be seen how investigations, prosecutorial discretion and the courts will treat the new offence but on its face, the lawyer could now be money laundering without knowing or believing the funds are proceeds of crime if the lawyer is only reckless about whether the funds are proceeds of crime. This could involve knowledge about the source of funds that make it appear likely that they are proceeds of crime, without the need to actually know or have come to believe it to be so.
The effect of this is that a financial services business must be looking for reckless transactors, not only transactors who appear to know or believe that transactional funds are proceeds of crime. This necessarily involves second-guessing the processes of clients. These individuals and businesses may, in the face of "clues" that they are dealing with proceeds of crime, nevertheless not believe them to be so. This could amount to recklessness.
It has always been an offence to believe one is laundering proceeds of crime even if the money in question is in fact completely legitimate. This may seem overly broad, but the policy choice made by Parliament was to criminalize those who were subjectively at fault because they believed they dealing with property obtained by crime or the proceeds of such property.
In application, the former offence, requiring knowledge or belief, has proven to be a difficult and expensive compliance problem for financial institutions. Money launderers modify their behaviour and develop innovative ways to carry out their transactions in order to extract the financial benefit of criminal activity and integrate their wealth back into circulation. This has pushed the financial industry into the role of being both reactive, updating and modifying AML programs, but also proactive, developing monitoring tools and sharing typologies in order to anticipate new ML tactics.
The new section 462.31, introduced without much fanfare, raises the bar for reporting entities and indeed any party to financial activity in the most broad sense. For first party transactors, there is now a specific obligation to rise above the level of recklessness in dealing with others. For businesses that provide financial services, in addition to the risk of becoming ensnared in a money laundering allegation through reckless behaviour, there is a new and significant obligation to ensure that their anti-money laundering program is set up to catch reckless parties to transactions.
Reduced to its essential core, the new substantive offence means that an entity commits money laundering if it is reckless about money laundering.
This is not an additional or separate offence. This is not just a FINTRAC issue. The actual criminal offence of money laundering can now be committed through recklessness without any additional subjective fault.
Among other things, the issue is no longer just what the party knows or believes. The suspicious transaction evaluation now must ask whether the party has done enough of its own evaluation to rise above recklessness, given the risk profile of the financial activity. Ultimately, this appears to involve a risk based assessment of the client's business activities to determine whether the client, given the risk profile its activity, has taken sufficient steps to prevent money laundering.
It is usually quite difficult to prove that a person knows something or holds a particular belief. It can certainly be done but given that admissions of wrongdoers are rare, the proof relies on circumstancial evidence that requires extensive resources and plenty of motivation. With the modification of the money laundering offence to include recklessness, the evidence can be much more objective in that a person, a company, and by extension, senior management may be guilty of money laundering in Canada now because they have not paid due regard to the risks associated with their transactions.
If this new reality has not been addressed yet within your organization, it is time to consider whether your AML program is now considering reckless behaviour. This will have an impact on all three lines of defence. This applies to policies and procedures, the training of staff, the monitoring tools implemented, practices around recording and reporting and internal audit and evaluation. In short, the overall program must address the criminal law concept of recklessness as established in Canada.
Here is a link to an article I co-wrote with colleagues at McCarthy Tétrault. The risk remains high. Given the strength of current security technology the largest vulnerability continues to be internal staff vulnerability to phishing and variants such as spearphishing.
Train your staff on the importance of only accessing trusted links to external sources, and techniques for identifying suspicious links. Then test them with mock phishing attacks to assess and revisit your training if required!
If you need an update to your cybersecurity policies or training, give us a call to see how we can help.