Banking's Proposed "Know Your Customer" Rules
CRS Report for Congress
Received through the CRS Web
“Know Your Customer” Rules
M. Maureen Murphy
American Law Division
On December 7, 1998, federal banking regulators proposed regulations that would
have required banks and thrifts to develop formal policies and procedures to identify
unusual transactions in customers’ accounts to report as suspicious activity in
conjunction with the federal laws outlawing money laundering. Since 1996, banks have
been required to report suspicious activity. Many institutions have maintained know-
your-customer procedures on an informal basis. Formal procedures subject to regulatory
scrutiny would have been, however, an innovation. On March 23, 1999, the regulators
issued a joint statement withdrawing the proposal, having received an unprecedented
number of comments.1 Small banks criticized the increased costs of screening.
Individuals and businesses raised privacy concerns. Although there were varied
proposals before the 106th Congress on the issue, no legislation was enacted. The issueth
likeliest to command attention in the 107 Congress is international money laundering.
There have been recent instances in which banking regulators imposed corrective action,
comparable to the Know Your Customer requirements, on several international banking
institutions after unearthing potential money laundering activity.
Anti-Money Laundering Laws. Money laundering involves concealing illegally
obtained income and recycling it until its illegal origin is completely obscured. It is
addressed primarily by four types of federal law: (1) recordkeeping and reporting
requirements with civil and criminal sanctions, (2) substantive criminal offenses, (3)
procedural protections against federal access to financial records, and (4) agreements with
foreign countries with respect to procedures and conditions under which financial records
may be secured for law enforcement purposes. The Bank Secrecy Act of 19702 and its
1 The FDIC received 254, 394 comments with an “overwhelming majority” “strongly opposed.”
2 12 U.S.C. §§ 1829b and 1951-1959, and 31 U.S.C. 5311-5322.
Congressional Research Service ˜ The Library of Congress
major component, the Currency and Foreign Transactions Reporting Act,3 require reports
and records of cash, negotiable instrument, and foreign currency transactions and authorize
the Secretary of the Treasury to prescribe regulations to insure that adequate records are
maintained of transactions that have a “high degree of usefulness in criminal, tax, or
regulatory investigations or proceedings.”4 The regulations set civil and criminal penalties
for their violation. There are also substantive federal criminal statutes that define as
offenses, laundering of monetary instruments5 and engaging in monetary transactions in67
property derived from unlawful activity. The Right to Financial Privacy Act details the
procedures that federal agencies, including law enforcement agencies, must use to gain
access to financial records of individuals. Treaties of mutual assistance with foreign
governments detail the conditions under which each signatory government may obtain
judicial assistance for access to financial information from institutions within the other
The Supreme Court upheld the constitutionality of the Bank Secrecy Act in
California Bankers Association v. Schultz, 416 U.S. 21 (1974), as a valid exercise of
federal power under the commerce clause. It ruled that the Bank Secrecy Act’s
recordkeeping and reporting burden was not so onerous as to deprive the institutions of
due process, did not involve an illegal search and seizure in violation of the Fourth
Amendment, and did not invade associational interests protected by the First Amendment.
Subsequently, in United States v. Miller, 425 U.S. 435 (1976), the Court held that the
Fourth Amendment does not recognize an expectation of privacy in a person’s financial
records held by a bank vis-a-vis a governmental agency’s interest in examining those9
records. Thereafter, the federal Right to Financial Privacy Act of 1978 was enacted with
a dual purpose: “protect[ing] the customers of financial institutions from unwarranted
intrusions into their records [by federal government authorities] while at the same time
permitting legitimate law enforcement activity.”10 It sets procedures for the federal11
government’s access to bank customer records. One of the exceptions to these
3 31 U.S.C. §§ 5311-5322.
4 12 U.S.C. § 1829b.
5 18 U.S.C. § 1956.
6 18 U.S.C. § 1957.
7 12 U.S.C. § § 3401 - 3422.
8 See Michael Abel and Bruno A. Ristau, 3 International Judicial Assistance §§ 12-4-1 and
related appendices (1990)
9 P.L. 95-630, Tit. XI, 92 Stat. 3641, 3697-3710; 12 U.S.C. §§ 3401 -2422.
10 H.Rept. 95-1383, 95th Cong., 2d Sess. 33; 1978 U.S.Code Cong. & Ad. News 9305.
11 RFPA’s application is extensive in terms of the information it covers and limited in terms of the
customers to which it applies. It defines “financial record” to include information derived from
records held by a financial institution pertaining to an individual or partnership of five or fewer
individuals. 12 U.S.C. §§ 3401(2), (4), and (5). It defines “financial institution” to mean “any
office of a bank, savings bank, card issuer..., industrial loan company, trust company, savings
association, building and loan, or homestead association (including cooperative banks), credit
union, or consumer finance institution, located in any State or territory of the United States, the
procedures states that “[n]othing in this ... [law] shall authorize the withholding of financial
records or information required to be reported in accordance with any Federal statute or
rule promulgated thereunder.”12 It, thus, effectively incorporates the Bank Secrecy Act
into the Right to Financial Privacy Act.
Implementing Regulations. The Currency and Foreign Transactions Reporting
Act requires financial institutions and other specified businesses to maintain records of
foreign domestic financial transactions and to report to the Secretary of the Treasury
certain currency transactions in excess of $10,000. A subsequent amendment, section
1359 of the Anti-Drug Abuse Act of 1986,13 ordered the federal banking regulators to
prescribe regulations “requiring insured banks to establish and maintain procedures
reasonably designed to assure and monitor the compliance of such banks with the
requirements of” the Bank Secrecy Act. Under the implementing regulations, promulgated
by the Financial Crimes Enforcement Network of the Department of the Treasury
(FinCen), the following types of reports are required: (1) Currency Transaction Reports
(CTR’s) on currency transactions of more than $10,000;14 and (2) reports relating to the
physical transportation of currency or monetary instruments from or into the United
States; regarding foreign financial accounts, or transactions with foreign financial
agencies.15 The regulations also require maintaining various records in connection with
purchases of bank checks, money orders, and traveler’s checks in excess of $3,000,16 as
well as copies of records of various other transactions that the Secretary of the Treasury
has determined to have a high degree of usefulness in investigative proceedings.17 Since
April, 1996,18 the regulations require that banks and other depository institutions submit
Suspicious Activity Reports (SARs)19 of any transaction involving at least $5,000, which
the institution suspects: to include funds from illegal activities; to have been conducted to
hide funds from illegal activities or designed to evade the BSA requirements; which have
“no business or apparent lawful purpose;” or are “not the sort [of transaction] in which
the particular customer would normally be expected to engage, and the bank knows of no
District of Columbia, Puerto Rico, Guam, American Samoa, or the Virgin Islands.”
12 12 U.S.C. § 3412(d).
13 P.L. 99-570, 100 Stat. 3207, 3207-27; 12 U.S.C. § 1818s.
14 31 C.F.R. § 103,22(a).
15 12 C.F.R. §§ 103.23 -.25.
16 31 C.F.R. § 103.29.
17 31 C.F.R. §§ 103.31 - 103.39.
18 61 Fed.Reg. 4326 (February 5, 1996). Included in the notice were implementing regulations
applicable to national banks and to state chartered member banks.12 C.F.R. §§ 21.11 and 208.20.
Promulgated soon thereafter were regulations applicable to state chartered nonmember banks; 12
C.F.R. § 353.3; federally insured credit unions (12 C.F.R. § 748.1); and federally insured savings
associations, 12 C.F.R. § 563.180.
19 31 C.F.R. § 103.21. The authority to require suspicious activity reports derives from 31 U.S.C.
§ 5314(h), authorizing the Secretary of the Treasury to require financial institutions to report
suspicious transactions, originally enacted as section 1518 of the Housing and Community
Development Act of 1992, P.L. 102-550, 106 Stat. 3672,4059.
reasonable explanation for the transaction after examining the available facts, including the
background and purpose of the transaction.”20 The banking regulators have also issued
rules requiring the institutions that they supervise to “establish and maintain procedures
reasonably designed to assure and monitor their compliance” with the Bank Secrecy Act
and regulations.21 One portion of these regulations requires that each institution develop
a written compliance program with internal controls, independent testing, training of
personnel, and designating individuals to coordinate and monitor an institution’s program.
The proposed “Know Your Customer” regulations would have expanded upon these
requirements . The Money Laundering Suppression Act of 199422 sets forth mandatory
exemptions to the currency reporting requirements that include other depository
institutions and governmental entities. It authorizes the Secretary of the Treasury to issue
regulations to permit institutions to designate business customers in certain categories as
exempt from the currency reporting requirements. Under the regulations that have been
issued, institutions are authorized to exempt banks, government entities, and publicly
traded companies according to one set of procedures, and companies not publicly traded
and business entities that use cash for their payrolls according to another set of procedures
which include biennial renewals.23
The “Know Your Customer” Proposed Regulations. In promulgating the
proposed “Know Your Customer” regulations, the bank regulators cited their authority
under the Bank Secrecy Act and their general authority to prevent practices that threaten
the safety and soundness of the institutions they supervise. They expected that the
regulations would decrease the likelihood that banking institutions would collude with
money launderers and jeopardize the reputations of their institutions. The regulators also
indicated that they saw formal regulatory requirements as support for institutions that
already have Know Your Customer policies in place when their customers question their
authority to inquire into transactions. The proposals would have meant regularized,
systematic increased scrutiny of documentation of customer’s identity, both individual and
corporate, and possible further investigation of persons, including private banking
clients,24 who begin or maintain relationships with regulated institutions.
20 31 C.F.R. § 103.21(a)(2).
21 52 Fed. Reg. 2858 (January 27, 1987), promulgating 12 C.F.R. § 21.21 (Office of the
Comptroller of the Currency, applicable to national banks); 12 C.F.R.§ .208.14 (subsequently, 12
C.F.R. § 208.63) (Board of Governors of the Federal Reserve System, applicable to state member
banks); 12 C.F.R. § 326.8 (Federal Deposit Insurance Corporation, applicable to federally insured
state nonmember banks); 12 C.F.R. § 563.17-7 subsequently 12 C.F.R. § 563.177(Federal Home
Loan Bank Board, the predecessor of the Office of Thrift Supervision, regulator of savings
associations, applicable to federally insured thrift institutions); and 12 C.F.R. § 742.2 (National
Credit Union Administration, applicable to federally insured credit unions).
22 P.L. 103-325, tit. 4, sec. 402 (a), 108 Stat. 2243, 31 U.S.C. § 513(d).
23 See 63 Fed. Reg. 50147 (September 21, 1998); 31 C.F.R. § 103.22.
24 Private banking includes “personalized services such as money management, financial advice,
and investment services for high net worth clients,” that “have become an increasingly important
aspect of the operations of some large, internationally active banking organizations.” Board of
Governors of the Federal Reserve System, SR 97-19 (SUP), at 1 (June 30,
1997)[http://www.federal reserve.gov/board docs/SRLETTERS/1997/SR9719.HTM]. The Know
Since June 1998, various banking institutions operating internationally have been
subjected to regulatory requirements by the Federal Reserve Bank of New York following
money laundering investigations calling into question their ability to monitor international25
transfers as required under the Currency and Foreign Transaction laws and regulations.
The extent of the regimes imposed on these institutions to enhance their due diligence
procedures with respect to private banking clients and international clients bears
considerable relationship to the Know Your Customer regime.
Legislation. In the 105th Congress, H.R. 4005, the Money Laundering Deterrence
Act of 1998, was passed by the House. It would have required the Secretary of the
Treasury to promulgate Know Your Customer regulations. H.Rept. 105-611, Part 1,
indicated that the House Banking Committee believed that law enforcement would be
enhanced by “strong legal mechanisms for detecting the flows of ...illicit proceeds” of “the
international drug trade and other global criminal enterprises,” and that detection was most26
likely at the point of entry into the financial system. A dissenting member of the
Committee, Representative Paul, raised concerns about the effectiveness of the reporting
requirements in stemming drug traffic, the paperwork and cost burdens of increased
reporting requirements, the potential for legal liability in connection with errors in27
reporting, and vulnerability to abuse by employees and penetration by hackers.
In the 107th Congress, H.R. 1114, offered by Rep. LaFalce for himself and Rep.
Velazquez, and a substantially similar bill, S. 398, introduced by Sen. Kerry, like H.R.th
3886 of the 106 Congress (H.Rept. 106-728), addresses the problem of international
money laundering. The approach it takes is to authorize the Secretary of the Treasury to
impose special recordkeeping and reporting requirements regarding financial transactions
between domestic institutions and those in foreign jurisdictions determined to be of
primary money laundering concern. Such requirements would be directed at securing
information on the identity of beneficial owners of funds being held for, transferred to, or
transferred from persons and financial institutions in the foreign jurisdiction. The
Secretary would also be empowered to place conditions on the establishment of
correspondent accounts with U.S. financial institutions by the banking organizations of
such a jurisdiction. Primary money laundering concern would be determined by weighing
such factors as the jurisdiction’s bank secrecy and tax laws, its banking supervision and
Your Customer rules follow revelations of how the private banking services of Citibank were
employed to aid Raul Salinas de Gortari, brother of Carlos Salinas, former president of Mexico,
in transferring large sums from Mexico to Swiss banks. See U.S. General Accounting Office,
“Private Banking: Raul Salinas, Citibank, and Alleged Money Laundering,” GAO/OSI-99-1
25 These included a cease and desist order directed against the Banco Nacional de Mexico, Banka
Serfin, Banco Internacional, Bancomer, and Banco Santander in June 1998; and written
agreements, sometimes with state regulators or other Federal Reserve banks, with the Bank of New
York, the Banco Popular de Puerto Rico, and the Banco Bilbao Vizcaya Argentaria. See Harold
Adams Crawford, “managing Reputation Risk: Bank Secrecy and Bank Privacy,” 19 Banking and
Financial Services Policy Report 1 (December 2000).
26 H.Rept. 105-611, Part 1, 9.
27 H.Rept. 105-611, Part 1, Dissenting View of Representative Ron Paul.
counter-money laundering laws, and its reputation as a tax haven or off-shore banking
haven. The legislation includes provisions to insulate financial institutions and personnel
from liability for reporting suspected violations of law. Also included are criminal penalties
for violating and structuring to avoid geographic targeting orders issued under the
authority of the Currency and Foreign Transactions Reporting Act.. The measure also
includes a provision permitting depository institutions to include information relating to
the possible involvement of an institution-affiliated person in potentially unlawful activity
in response to an employment inquiry from another financial institution. Federal regulators
are to provide Congress with a report reconciling the penalties under the Currency and
Foreign Transaction Reporting Act with those under the enforcement provisions of the
Federal Deposit Insurance Act. Included are statements respecting the sense of Congress
on measures to be taken respecting corruption of foreign governments and how the United
States should support the activities of the Financial Action Task Force on Money
Included in S. 16, introduced by Sen. Daschle, as sections 2201 to 2223, is “The
Money Laundering Enforcement Act of 2001,” containing various amendments to the
substantive money laundering provisions. One permits forfeiture of a money transmitting
business operating with a state license upon proof that the defendant knew that the
business lacked such a license. Others authorize procedures for the Attorney General to
seek restraint of the U.S. assets of persons arrested or charged in a foreign country of
money laundering or Controlled Substances Act offenses; provide authority for asserting
jurisdiction over foreign persons committing a money laundering offense involving a
transaction occurring in part in the United States; extend the coverage of the criminal
money laundering statutes to foreign banks; and add various crimes to the list of money
laundering predicate offenses. Also included are various amendments to criminal procedure
respecting the prosecution and presentation of evidence in money laundering cases,
encouraging financial institutions to notify law enforcement officer of suspicious
transactions, amending the substantive money laundering criminal statute to reach conduct
that involves funds commingled with the proceeds of illegal activity, and extending
criminal penalties to violations of geographic targeting orders.
S. 1371, introduced by Sen. Levin, would add foreign corruption offenses to the list
of predicates under the federal money laundering statutes, require financial institutions to
keep records of the owners of interests in accounts held in the name of foreign entities,
prohibit correspondent accounts with offshore shell banks, require enhanced due diligence
procedures for private banking relations with foreign persons, provide federal court
jurisdiction over foreign persons committing money laundering offenses, provide
jurisdiction over money laundering through a foreign bank, prohibit false statements to a
financial institution regarding the identity of a customer, require the Secretary of the
Treasury to issue regulations regarding concentration accounts held in U.S. depository
institutions in the name of foreign banks, permit charging multiple instances of money
laundering in a single count of an indictment, allow seizure of funds held in a U.S. bank’s
interbank accounts for a foreign bank, and enhance procedures for law enforcement access
to bank records and to forfeit substitute property.