Earlier this summer, the U.S. Treasury Department published a 147-page report, “A Financial System That Creates Economic Opportunities,” which outlines a rollback of several of the regulatory measures put in place in the wake of the financial crisis. Against this backdrop of financial markets deregulation, many financial institutions have been taking a hard look at their compliance department costs and asking the question: do we really need all of this?

While there is an inherent logic to the move, there are also some significant risks involved with compliance department cost reductions. Yes, with the threat of enforcement decreased, it can make sense on paper to cut back on some of the estimated $1 billion per year that many top-tier banks and financial firms spend on compliance-related costs. But is cutting spending alone really the right approach? Or, should financial institutions be taking this opportunity to reevaluate their focus on more efficient and effective means of financial crimes compliance, factoring in the value that compliance and operational staff bring to their enterprises?

Compliance and operations staff help protect the bottom line by ensuring that financial transactions are properly executed and are also in line with the law and industry practice. In fulfilling their mission, compliance and operations staff can root out financial frauds that may negatively impact the firm’s bottom line.

The recent action concluded by the Securities and Exchange Commission against Nathaniel D. Ponn (“Ponn”) provides a good case in point.

As the SEC Complaint alleges, from 2007 to April 2015, Ponn established approximately 600 brokerage accounts at 17 brokerage firms. Ponn funded the accounts with bogus bank transfers totaling over $8.7 million, with $7.4 million in fraudulent transfers occurring in 2014 and 2015.

The transfers mostly involved payments that Ponn initiated via the Automated Clearing House (“ACH”) network from underfunded or fictitious bank accounts. The ACH payments immediately generated credits in the brokerage accounts. Prior to account verification—a process that typically takes three days—the brokerage account holder can use the credits in the account to buy and sell securities. Ponn’s scheme exploited that lag time. With the millions in credits received prior to funds verification, Ponn purchased $2.9 million worth of securities.

It has been said that “compliance is good business.” The facts of the Ponn case remind that by following best practices, brokers and clearing operations can promptly identify similar fraudulent securities schemes and limit any losses.

The good news was that the internal controls of the brokerage firms prevented Ponn from causing significant financial harm. Some did not credit Ponn’s brokerage accounts in whole or in part until they verified the existence of Ponn’s bank accounts and the sufficiency of his funds. Some broker-dealers rejected Ponn’s attempts to transfer cash and securities to another brokerage account. Ponn also attempted to withdraw cash before the bank transfers were confirmed, but he was only successful in cashing out a mere $300. The broker-dealers also locked down Ponn’s accounts after discovering that his initial deposits were fraudulent, then sold the securities purchased to realize gains or losses. In the end, Ponn’s fraudulent securities purchases resulted in $26,000 in net trading losses, though his activities put these brokerage firms at risk for much more.

Ponn was ultimately prosecuted by the Department of Justice and SEC. In December 2016, Ponn pleaded guilty to three counts of wire fraud; he was later sentenced to fifteen months in jail and ordered to pay $20,000 in restitution to the aggrieved brokerage firms. On May 23, 2017, the SEC announced a Final Judgment against Ponn where he consented to violations of U.S. anti-fraud regulations.

Because the SEC and Justice Department cases were settled, there are scant details in the public record on precisely how the brokerage firms identified and largely thwarted Ponn’s scheme. That being said, the Ponn case does provide a welcome opportunity to highlight some best practices that brokerage operations can follow to prevent or mitigate losses from other Ponn-type schemes. Below are five best practices.

1. Effective customer due diligence. Brokers must have robust customer due diligence procedures that require the firm to vet any potential clients. Firms must uncover any derogatory information about their customers and gather and assess source of funds and wealth information to determine if the customer presents a fraud or money-laundering risk.

2. Monitor inbound funds transfers. Brokers should meticulously track all inbound funds transfers to ensure all transfers are consummated with adequate funds. With the SEC’s shortening of the settlement cycle to two days following trade date (i.e., T+2), effective September 2017, brokers will be under increased time pressure to validate that their customers have sufficient funds to pay for their securities trades.

3. Monitor journal transfers to error or suspense accounts. Brokers should also implement automated surveillance tools calibrated to detect for fraudulent activity. For example, surveillance tools should detect for patterns of suspicious journal transfers of securities positions, such as where securities are transferred from customer accounts to error or suspense accounts. Such a journal transfer could be the result of a purchase transaction cancelled due to insufficient funds.

4. Escalate to legal/AML compliance for investigation and report any suspicious activity. Where the client is suspected of having opened an account with insufficient funds, or of having a securities purchase scuttled for the same, the matter should be promptly escalated to legal or AML compliance staff for investigation. The broker’s procedures should require that any suspected fraudulent accounts are frozen and any associated securities positions liquidated. The firm’s procedures should also provide for the filing of a suspicious activity report with the regulator.

5. Swiftly close fraudulent accounts. Brokers must swiftly close any fraudulent accounts. Working with appropriate business and operations partners, the AML department staff should monitor actions taken to restrict and ultimately close the accounts of the fraudster.  AML staff should also make sure that processes are in place to identify any attempts by the fraudster to open an account under his name or under the name of a related party. After all, it would not be the first time that a fraudster has crawled in the window after having been previously “shown the door.”

It has been said that “compliance is good business.” The facts of the Ponn case remind that by following best practices, brokers and clearing operations can promptly identify similar fraudulent securities schemes and limit any losses. 


Jay Lippman is a Managing Director in Exiger’s New York Office, where is advises on financial crime compliance matters. He has more than nineteen years’ experience in the securities industry as both a regulator and a member of in-house financial crime compliance teams. Martin J. Foncello is an Associate Director, also in Exiger’s New York Office.