Davis Polk & Wardwell Newsflash

FinCEN Clarifies the Obligations of Clearing Firms Under the Customer Identification Program Rule

March 21, 2008

On March 4, 2008, the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) issued a significant no-action position clarifying its position respecting the customer identification program rule (“CIP rule”) obligations of clearing firms. 

The CIP rule requires registered broker-dealers to establish a written Customer Identification Program that includes risk-based procedures for verifying the identity of each customer to the extent reasonable and practicable, as part of the broker-dealer’s anti-money laundering compliance program.  The rules of broker-dealer self-regulatory organizations permit registered broker-dealers that act as introducing firms and clearing firms to allocate regulatory and operational functions between themselves under the terms of a clearing agreement.  Typically, clearing agreements allocate responsibility for opening and approving accounts and directly receiving and accepting orders from the introduced customers (“CIP functions”) exclusively to the introducing firms and allocate the functions of extending credit, safeguarding funds and securities, and issuing confirmations and statements to the clearing firm. 

When a clearing agreement allocates CIP functions in this manner, FinCEN will not require the clearing firm to comply with the requirements of the CIP rule with respect to customers introduced by an introducing firm pursuant to the clearing agreement.  Instead the responsibility will fall to the introducing broker.  This extends to piggybacking arrangements, whereby an introducing firm does not enter into a clearing agreement directly with a clearing firm, but rather establishes a relationship with an introducing firm that has established a clearing agreement with a clearing firm, thus “piggybacking” off the intermediary firm’s clearing agreement.  In this case, both the clearing firm and the intermediary introducing firm may rely on the piggybacking firm’s compliance with the CIP rule if the piggybacking firm is allocated responsibility for CIP functions under its contract with the intermediary.

A clearing firm’s anti-money laundering program should still contain risk-based policies, procedures and controls for assessing the money laundering risk posed by its fully disclosed clearing arrangements, for monitoring and mitigating that risk, and for detecting and reporting suspicious activity.  Likewise, an introducing firm’s anti-money laundering program should contain risk-based policies, procedures and controls with respect to both its direct customers and any customers that may be introduced by a piggybacking firm. 

If you have any questions regarding this newsflash, please call your Davis Polk contact.

Davis Polk & Wardwell