LECLAIR RYAN, A PROFESSIONAL CORPORATION Thomas J. McGonigle 1701 Pennsylvania Avenue NW, Suite 1045 Washington, DC 20006 tmcgonigle@ leclairryan.com direct dial: 202.659.6700 main phone: 202.659.4140 fax: 202.659.4130 Biography

KNOW THY CUSTOMER: NEW ANTI-MONEY LAUNDERING AND BOOKS & RECORDS REQUIREMENTS

Risk Management Tip: Individuals conducting supervisory reviews need to take into consideration information contained in all relevant records maintained by the firm, rather than just relying on memory.

KNOW THY CUSTOMER: NEW ANTI-MONEY LAUNDERING AND BOOKS & RECORDS REQUIREMENTS

Thomas J. McGonigle*
Julie M. Russo*

On November 2, 2001, the U.S. Securities and Exchange Commission ("S.E.C.") amended Rules 17a-3 and 17a-4 of the Securities Exchange Act of 1934 (the "Exchange Act") to expand the books and records requirements for broker-dealers. The following outline delineates the current books and records requirements and the S.E.C.'s expansion of these requirements effective May 2, 2003 (in bold typeface), additional books and records requirements effective May 2, 2003, electronic storage media requirements, and new requirements as a result of recent anti-money laundering measures.

I. CURRENT AND EXPANDED REQUIREMENTS (IN BOLD TYPEFACE):

A broker-dealer must maintain for at least three years (with the exception of items 1-3, 5, and 25, which a broker-dealer must maintain for at least six years, and items 15 and 26, which a broker-dealer must maintain for life):

1. Blotters or other records of original entry containing an itemized daily record of:

a. All purchases and sales of securities;
b. All receipts and deliveries of securities (including certificate numbers);
c. All receipts and disbursements of cash and all other debits and credits.

Such records must show:
d. The account for which each transaction was effected;
e. The name and amount of securities;
f. The unit and aggregate purchase or sale price (if any);
g. The trade date;
h. The name or other designation of the person from whom purchased or received or to whom sold or delivered.

2. Ledgers or other records reflecting all:
a. Assets and liabilities;
b. Income and expenses;
c. Capital accounts.

3. Ledgers or other records itemizing separately as to each cash and margin account of every customer and of the broker-dealer and partners thereof all:
a. Purchases;
b. Sales;
c. Receipts;
d. Deliveries of securities and commodities and all other debits and credits to such account.

4. Ledgers or other records reflecting:
a. Securities in transfer;
b. Dividends and interest received;
c. Securities borrowed and securities loaned;
d. Moneys borrowed and moneys loaned (together with a record of the collateral therefor and any substitutions in such collateral);
e. Securities failed to receive and failed to deliver;
f. All long and short securities record differences arising from the examination, count, verification and comparison pursuant to Exchange Act Rules 17a-5, 17a-12, and 17a-13 (by date of examination, count, verification and comparison showing for each security the number of shares of long or short count differences);
g. Repurchase and reverse repurchase agreements.

5. A securities record reflecting separately for each security as of the clearance dates all:
a. "Long" or "short" positions (including securities in safekeeping and securities that are the subjects of repurchase or reverse repurchase agreements) carried by the broker-dealer for its account or for the account of its customers or partners or others;
b. The location of all securities long and the offsetting position to all securities short, including long security count differences and short security count differences classified by the date of the physical count and verification in which they were discovered, and in all cases the name or designation of the account in which each position is carrie
d.

6. A memorandum of each order, whether executed or unexecuted, showing:
a. The terms and conditions of the order or instructions, and any modification or cancellation thereof;
b. The account for which entered;
c. The time of entry;
d. The price at which executed;
e. The time of execution or cancellation (to the extent feasible);
f. A designation for orders entered pursuant to the exercise of discretionary power;
g. The time the order was received;
h. The identity of each associated person, if any, responsible for the account;

i. The identity of any other person who entered or accepted the order on behalf of the customer (or a notation that the customer entered the order by him/herself on an electronic system).

7. A memorandum of each purchase and sale of securities for the account of the broker-dealer showing:
a. The price;
b. The time of execution (to the extent feasible);
c. Where such purchase or sale is with a customer other than a broker or dealer, the time of receipt, the terms and conditions of the order, and the account in which it was entered;
d. In addition to the terms and conditions of the order, any modifications thereof;
e. The identity of each associated person, if any, responsible for the account;
f. The identity of any other person who entered or accepted the order on behalf of the customer (or a notation that the customer entered the order by him/herself on an electronic system);
g. For orders by a customer other than a member, broker, or dealer, a designation that the order was entered pursuant to the exercise of discretionary power by the broker-dealer.
8. Copies of confirmations of all purchases and sales of securities, including all repurchase and reverse repurchase agreements, and copies of notices of all other debits and credits for securities, cash, and other items for the account of customers and partners of such broker-dealer.
9. With respect to each cash and margin account, a record indicating:
a. The name and address of the beneficial owner of such account;
b. Except with respect to exempt employee benefit plan securities, but only to the extent such securities are held by employee benefit plans established by the issuer of the securities whether not the beneficial owner of securities registered in the name of the broker-dealer, or a registered clearing agency or its nominee objects to disclosure of his/her identity, address and securities positions to issuers;
c. In the case of a margin account, the signature of such owner (provided that in the case of a joint account or an account of a corporation, such records are required only with respect to the person or persons authorized to transact business for such account).

10. A record of all puts, calls, spreads, straddles, and other options in which the broker-dealer has any direct or indirect interest or which the broker-dealer has granted or guaranteed, containing, at least, an identification of the security and the number of units involve
d.

11. A record of the proof of money balances of all ledger accounts in the form of trial balances, and a record of the computation of aggregate indebtedness and net capital, as of the trial balance date (pursuant to Exchange Act Rule 15c3-1). Such trial balances and computations shall be prepared currently at least once a month.

12. A questionnaire or application for employment executed by each "associated person" of the broker-dealer, which has been approved in writing by an authorized representative of the broker-dealer and shall contain at least the following information with respect to each person:

a. Name;
b. Address;
c. Social security number;
d. Employment starting date (or other association with the broker-dealer);
e. Date of birth;
f. A complete, consecutive statement of all business connections for at least the preceding ten years, including whether the employment was part-time or full-time;
g. A record of any denial of membership or registration, and of any disciplinary action taken, or sanction imposed by any federal or state agency, or by any national securities exchange or national securities association, including any finding that the person caused disciplinary action or had violated any law;
h. A record of any denial, suspension, expulsion or revocation of membership or registration of any member, broker, or dealer with which the person was associated in any capacity when such action was taken;
i. A record of any permanent or temporary injunction entered against the person or any member, broker or dealer with which the person was associated in any capacity at the time such injunction was entered;
j. A record of any arrest or indictment for any felony, or any misdemeanor pertaining to securities, commodities, banking, insurance or real estate (including, but not limited to, acting as or being associated with a broker-dealer, investment company, investment adviser, futures sponsor, bank, or savings and loan association), fraud, false statements or omissions, wrongful taking of property or bribery, forgery, counterfeiting or extortion, and the disposition of the foregoing;
k. A record of any other name or names by which the person has been known or has used, provided, however, that if such associated person has been registered as a registered representative of the broker-dealer with, or the person's employment has been approved by, the NASD, or the American Stock Exchange LLC, the Boston Stock Exchange, Inc., the Chicago Stock Exchange, Inc., the NYSE, the Pacific Exchange, Inc., the Philadelphia Stock Exchange, Inc., the Chicago Board Options Exchange, Inc., the Cincinnati Stock Exchange, Inc., or the International Securities Exchange, then retention of a full, correct and complete copy of any and all applications for such registration or approval shall be deemed satisfactory;

l. Every office of the broker-dealer where the associated person regularly conducts the business of handling funds or securities or effecting any transactions in, or inducing or attempting to induce the purchase or sale of any security for the broker-dealer, the associated person's CRD number, and every internal identification number or code assigned to that person by the broker-dealer.
13. The processed fingerprint card or any substitute record when such card is not returned after processing, together with any information received from the Attorney General, for every person required to be fingerprinted under Rule 17f-2 of the Exchange Act.
14. Copies of all Forms X-17F-1A, all agreements between reporting institutions regarding registration or other aspects of Exchange Act Rule 17f-1, and all confirmations or other information received from the S.E.C. as a result of inquiry.
15. Records required to be maintained pursuant to Rule 17f-2(e) of the Exchange Act.
16. Certain records concerning any internal broker-dealer system sponsored by the broker-dealer.
17. All checkbooks, bank statements, canceled checks, and cash reconciliations.
18. All bills receivable or payable (or copies thereof), paid or unpaid, relating to the business of the broker-dealer.
19. Originals of all communications received and copies of all communications sent by the broker-dealer (including interoffice memoranda and communications) relating to the broker-dealer's business, and any approvals thereof.
20. All trial balances, computations of aggregate indebtedness and net capital (and working papers in connection therewith), financial statements, branch office reconciliations, and internal audit working papers, relating to the business of the broker-dealer.
21. All guarantees of accounts and all powers of attorney and other evidence of the granting of any discretionary authority given in respect of any account, and copies of resolutions empowering an agent to act on behalf of a corporation.
22. All written agreements (or copies thereof) entered into by the broker-dealer relating to its business, including agreements with respect to any account.
23. Records which contain the following information in support of amounts included in the report prepared as of the audit date on Form X-17A-5, Part II or Part IIA or Part IIB and in the annual financial statements and schedules required by sections 17a-5(d) and 17a-12(b) of the Exchange Act:

a. Money balance position, long or short, including description, quantity, price and valuation of each security including contractual commitments in customers' accounts, in cash and fully secured accounts, partly secured accounts, unsecured accounts and in securities accounts payable to customers;

b. Money balance and position, long or short, including description, quantity, price and valuation of each security including contractual commitments in non-customers' accounts, in cash and fully secured accounts, partly secured and unsecured accounts and in securities accounts payable to non-customers;

c. Position, long or short, including description quantity, price and valuation of each security including contractual commitments included in the Computation of Net Capital as commitments, securities owned, securities owned not readily marketable, and other investments owned not readily marketable;

d. Amount of secured demand note, description of collateral securing such secured demand note including quantity, price and valuation of each security and cash balance securing such secured demand note;

e. Description of futures commodity contracts, contract value on trade date, market value, gain or loss, and liquidating equity or deficit in customers' and non-customers' accounts;

f. Description of futures commodity contracts, contract value on trade date, market value, gain or loss, and liquidating equity or deficit in trading and investment accounts;

g. Description, money balance, quantity, price and valuation of each spot commodity, position or commitments in customers' and non-customers' accounts;

h. Description, money balance, quantity, price and valuation of each spot commodity, position or commitments in trading and investment accounts;

i. Number of shares, description of security, exercise price, cost and market value of put and call options including short out of the money options having no market or exercise value, showing listed and unlisted put and call options separately;

j. Quantity, price and valuation of each security underlying the haircut for undue concentration made in the Computation for Net Capital;

k. Description, quantity, price and valuation of each security and commodity position or contractual commitment, long or short, in each joint account in which the broker or dealer has an interest, including each participant's interest and margin deposit;

l. Description, settlement date, contract amount, quantity, market price, and valuation for each aged failed to deliver requiring a charge in the Computation of Net Capital pursuant to Exchange Act Rule 15c3-1;

m. Detail relating to information for possession or control requirements under Exchange Act Rule 15c3-3 and reported on the schedule in Part II or Part IIA of Form X-17A-5;

n. Detail of all items, not otherwise substantiated which are charged or credited in the Computation of Net Capital pursuant to Exchange Act Rule 15c3-1, such as cash margin deficiencies, deductions related to securities values and undue concentration, aged securities differences and insurance claims receivable;

o. Other schedules which are specifically prescribed by the S.E.C. as necessary to support information reported as required by sections 17a-5 and 17a-12 of the Exchange Act.

24. Records required to be made pursuant to Exchange Act Rule 15c3-4 and the results of periodic reviews conducted pursuant to Exchange Act Rule 15c3-4(d).

25. After the closing of any customer's account, any account cards or records which relate to the terms and conditions with respect to the opening and maintenance of such account.
26. All articles of incorporation or charter, minute books, and stock certificate books, and:

a. All Form BDs;
b. All Form BDWs;
c. All amendments to Form BDs and BDWs;
d. All licenses or other documentation showing the broker-dealer's registration with any securities regulatory authority.

II. NEW REQUIREMENTS:

A broker-dealer must maintain for at least three years (with the exception of items 1, 7 and 8, which a broker-dealer must maintain for at least six years, and item 11 which a broker-dealer must maintain for at least eighteen months after the report is generated):

1. For each account with a natural person as a customer or owner:

a. An account record including the customer's or owner's name, tax identification number, address, telephone number, date of birth, employment status (including occupation and whether the customer is an associated person of a member, broker or dealer), annual income, net worth (excluding value of primary residence), and the account's investment objectives. In the case of a joint account, the account record must include personal information for each joint owner who is a natural person; however, financial information for the individual joint owners may be combine
d. The account record shall indicate whether it has been signed by the associated person responsible for the account, if any, and approved or accepted by a principal of the member, broker or dealer. For accounts already in existence on May 2, 2003, the broker-dealer must obtain this information within three years of such date.

b. A record indicating that:

i. The broker-dealer has furnished to each customer or owner within three years of May 2003, and to each customer or owner who opened an account after May 2003, within thirty days of the opening of the account, and thereafter at intervals no greater than thirty-six months, a copy of the account record or an alternate document with all information required by paragraph a. above. The broker-dealer may elect to send this notification with the next statement mailed to the customer or owner after the opening of the account. The broker-dealer shall include with the account record or alternative document provided to each customer or owner an explanation of any terms regarding investment objectives. The account record or alternate document furnished to the customer or owner shall include or be accompanied by prominent statements that the customer or owner should mark any corrections and return the account record or alternate document to the broker-dealer, and that the customer or owner should notify the broker-dealer, of any future changes to information contained in the account record.

ii. For each account record updated to reflect a change in the name or address of the customer or owner, the broker-dealer furnished a notification of that change to the customer's old address, or to each joint owner, and the associated person, if any, responsible for that account, on or before the 30th day after the date the broker-dealer received notice of the change.

iii. For each change in the account's investment objectives, the broker-dealer has furnished to each customer or owner, and the associated person, if any, responsible for that account a copy of the updated customer account record or alternative document with all information required to be furnished by paragraph b.i. above on or before the 30th day after the date the broker-dealer received notice of any change, or, if the account was updated for some reason other than the firm receiving notice of a change, after the date the account record was update
d.

c. If an account is a discretionary account, a record containing the dated signature of each customer or owner granting the authority and the dated signature of each natural person to whom discretionary authority was grante
d.

d. A record for each account indicating that each customer or owner was furnished with a copy of each written agreement entered into on or after May 2003 pertaining to that account and that, if requested by the customer or owner, the customer or owner was furnished with a fully executed copy of each agreement.

2. A record as to each associated person of each written customer complaint received by the broker-dealer concerning that associated person. The record shall include the complainant's name, address, and account number; the date the complaint was received; the name of any other associated person identified in the complaint; a description of the nature of the complaint; and the disposition of the complaint. Instead of the record, the broker-dealer may maintain a copy of each original complaint in a separate file by the associated person named in the complaint along with a record of the disposition of the complaint.

3. A record indicating that each customer has been provided with a notice containing the address and telephone number of the department to which any complaints as to the account may be directe
d.

4. A record as to each associated person listing each purchase and sale of a security attributable, for compensation purposes, to that associated person. The record shall include the amount of compensation if monetary and a description of the compensation if non-monetary. In lieu of making this record, the broker-dealer may elect to produce the required information promptly upon request of a representative of a securities regulatory authority.

5. A record of all agreements pertaining to the relationship between each associated person and the broker-dealer including a summary of each associated person's compensation arrangement or plan with the broker-dealer, including commission and concession schedules and, to the extent that compensation is based on factors other than remuneration per trade, the method by which the compensation is determined.

6. A record, which need not be separate from the advertisements, sales literature, or communications, documenting that the broker-dealer has complied with, or adopted policies and procedures reasonably designed to establish compliance with, applicable federal requirements and rules of a self-regulatory organization of which the broker-dealer is a member which require that advertisements, sales literature, or any other communications with the public by a member, broker or dealer or its associated persons be approved by a principal.

7. A record for each office listing, by name or title, each person at that office who, without delay, can explain the types of records the firm maintains at that office and the information contained in those records.

8. A record listing each principal responsible for establishing policies and procedures that are reasonably designed to ensure compliance with any applicable federal requirements or rules of a self-regulatory organization of which the member, broker or dealer is a member that require acceptance or approval of a record by a principal.

9. Each report which a securities regulatory authority has requested or required the broker-dealer to make and furnish to it pursuant to an order or settlement, and each securities regulatory authority examination report.

10. Each compliance, supervisory, and procedures manual, including any updates, modifications, and revisions to the manual, describing the policies and practices of the broker-dealer with respect to compliance with applicable laws and rules, and supervision of the activities of each natural person associated with the broker-dealer until three years after the termination of the use of the manual.

11. All reports produced to review for unusual activity in customer accounts.

III. ELECTRONIC STORAGE MEDIA REQUIREMENTS:

1. Prior to employing any electronic storage media, a broker-dealer must notify its examining authority designated pursuant to Section 17(d) of the Exchange Act of employment of such storage media. If the broker-dealer plans to employ any electronic storage media other than optical disk technology, the broker-dealer must notify its designated examining authority at least 90 days prior to employment of such storage medi
a. In either case, the broker-dealer must provide its own representation or one from a storage medium vendor or other third party with appropriate expertise that the selected storage media meets the conditions set forth below:

a. Records are stored on microfilm or microfiche (or any similar medium), or a digital storage medium or system;

b. The electronic storage media preserves records exclusively in a non-rewriteable, non-erasable format;

c. The electronic storage media automatically verifies the quality and accuracy of the storage media recording process;

d. The electronic storage media serializes the original, and, if applicable, duplicates units of storage media, and time-dates for the required period of retention the information placed on such electronic storage media;

e. The electronic storage media has the capacity to readily download indexes and records preserved on it to any medium acceptable according to this section 1, as required by the S.E.C. or the self-regulatory organizations of which the broker-dealer is a member ("SRO").

2. The broker-dealer must at all times have available, for examination by the S.E.C. and SRO, facilities for immediate, easily readable projection or production of micrographic media or electronic storage media images and for producing easily readable images.

3. The broker-dealer must at all times be ready to provide, and immediately provide, any facsimile enlargement that the S.E.C., SRO, or any state securities regulator that has jurisdiction over the broker-dealer (the "State") may request.

4. The broker-dealer must store, separately from the original, a duplicate copy of any record stored on electronic storage media for the time require
d.

5. The broker-dealer must organize and index accurately all information maintained on both original and any duplicate storage medi
a. Such indexes must be available for examination by the S.E.C. and SRO. Each index must be duplicated and the duplicate copies must be stored separately from the original copy of each index. Original and duplicate indexes must be preserved for the time required for the indexed records.

6. The broker-dealer must have in place an audit system providing for accountability regarding inputting of records required to be maintained and preserved to electronic storage media and inputting of any changes made to every original and duplicate record maintained and preserved thereby. At all times, the results of such audit system must be available for examination by the S.E.C. and SRO. The audit results must be preserved for the time required for the audited records.

7. The broker-dealer must maintain, keep current, and provide promptly upon request by the S.E.C. or SRO, all information necessary to access records and indexes stored on the electronic storage media; or place in escrow and keep current a copy of the physical and logical file format of the electronic storage media, the field format of all different information types written on the electronic storage media and the source code, together with the appropriate documentation and information necessary to access records and indexes.

8. At least one third party (the "undersigned") who has access to and the ability to download information from the broker-dealer's electronic storage media to any acceptable medium shall file with the designated examining authority for the broker-dealer the following undertakings with respect to such records:

The undersigned hereby undertakes to furnish promptly to the U.S. Securities and Exchange Commission ("Commission"), its designees or representatives, any self-regulatory organization of which it is a member, or any State securities regulator having jurisdiction over the member, broker or dealer upon reasonable request, such information as is deemed necessary by the staffs of the Commission, any self-regulatory organization of which it is a member, or any State securities regulator having jurisdiction over the member, broker or dealer to download information kept on the broker's or dealer's electronic storage media to any medium acceptable under Rule 17a-4.

Furthermore, the undersigned hereby undertakes to take reasonable steps to provide access to information contained on the broker's or dealer's electronic storage media, including, as appropriate, arrangements for the downloading of any record required to be maintained and preserved by the broker or dealer pursuant to Rules 17a-3 and 17a-4 under the Securities Exchange Act of 1934 in a format acceptable to the staffs of the Commission, any self-regulatory organization of which it is a member, or any State securities regulator having jurisdiction over the member, broker or dealer. Such arrangements will provide specifically that in the event of a failure on the part of a broker or dealer to download the record into a readable format and after reasonable notice to the broker or dealer, upon being provided with the appropriate electronic storage medium, the undersigned will undertake to do so, as the staffs of the Commission, any self-regulatory organization of which it is a member, or any State securities regulator having jurisdiction over the member, broker or dealer may request.

IV. NEW ANTI-MONEY LAUNDERING REQUIREMENTS:
1. Pursuant to the USA Patriot Act (policies of which will change throughout the year and beyond), all broker-dealers must have by April 24, 2002:

a. Established written anti-money laundering policies, procedures, and controls;
b. Designated a Compliance Officer to be in charge of the program;
c. Implemented an on-going employee education and training program;
d. Established an independent audit function to test the program.
2. Under existing anti-money laundering laws, all broker-dealers should be:

a. Complying with reporting and recordkeeping requirements of the Bank Secrecy Act (i.e. filing Currency Transaction Reports ("CTRs"), Currency and Monetary Instrument Transportation Reports ("CMIRs"), and Reports of Foreign Bank and Financial Accounts ("FBARs") when necessary, and adhering to recordkeeping requirements with regard to funds transfers and transmittals over $3,000).
b. Conducting proper due diligence with regard to customer accounts by obtaining various identifying information from the customer, ascertaining the financial background of the customer, determining the source of all funds, and learning the trading pattern likely to occur in the account in order to spot future unusual trading activity.
3. On June 28, 2002, the Treasury Department issued final rules that will extend the requirements of Suspicious Activity Reports ("SARs") to which bank affiliates are already subject to all broker-dealers. Effective January 1, 2003, broker-dealers must report a transaction or series of transactions greater than $5,000 in funds or assets to the Treasury Department's Financial Crimes Enforcement Network ("FinCEN") within thirty days after the broker-dealer knows, suspects, or has reason to suspect that the transaction falls within one or more of the following four classes:

a. Transactions involving funds derived from illegal activity or intended or conducted in order to hide or disguise funds derived from illegal activity;
b. Transactions designed, whether through structuring or other means, to evade the requirements of the Bank Secrecy Act;
c. Transactions that appear to serve no business or apparent lawful purpose or are not the sort of transactions in which the particular customer would be expected to engage, and for which the broker dealer knows of no reasonable explanation after examining the available facts;
d. Transactions intended to further a criminal purpose, but apparently involving legally-derived funds. (This last category involves the use of the broker-dealer to facilitate criminal activity, including terrorism.)
4.
No later than October 25, 2002, the Treasury Department is scheduled to have new rules for verifying the identity of accountholders, which will require broker-dealers to:

a. Verify the identity, including the name and address, of any person opening an account by checking a suitable photo ID;
b. Maintain a record of the information used to verify the identity of new accountholders;
c. Check new accounts against lists of known or suspected terrorists and terrorist organizations.

The Treasury Department and the Social Security Administration are currently developing a system with which financial institutions may access a database to verify the authenticity of Social Security Numbers provided by customers.

V. CLOSING REMARKS:
1. New books and records requirements regarding customer account information will place a continuing obligation on broker-dealers to "know thy customer" by updating such information at least every three years.
2. In addition to the costs that broker-dealers will have to incur to comply with the new books and records requirements, broker-dealers should expect to incur costs in implementing the new anti-money laundering requirements.
3. With regard to the new anti-money laundering requirements that will mandate the verification of accountholders, the Treasury Department has asked for comments with regard to how the proposed rule will affect accounts designed to permit customers to execute transactions immediately and whether the proposed rule might conflict with state laws.

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