perform civil compliance checks, and criminal investigation, for investigating criminal violations of the act.

Institutions under examination's jurisdiction for compliance checks include check-cashing services, if such services are a primary business, and other currency exchange operations, except coin dealers; issuers, redeemers or cashiers of travelers checks, money orders, or similar instruments; licensed senders or transmitters of funds abroad for others; telegraph companies which transfer funds domestically or internationally; licensed gambling casinos having gross annual gaming revenue in excess of $1 million; and the domestic branch, agent, or agency of a foreign bank which is not supervised by one of the Federal banking agencies, such as a law firm acting as an agent for a foreign bank.

As a result of Treasury Order 105-13, examination also has responsibility for enforcing the civil aspects of the exemption provisions of the Bank Secrecy Act.

In addition, we have responsibility for assuring compliance with the filing of currency transaction reports-for those banks not currently examined by any of the other Federal supervisory agencies-for safety or soundness, such as State chartered banks, savings and loan associations, or credit unions.

Compliance checks are necessary to ensure integrity with the filing requirements. However, another real benefit to be derived from currency transaction information will be their use in identifying returns in need of examination for those who are not complying with the income tax requirements. In this sense, a major role of the examination function is as the end-user for all of the information generated by this act.

Therefore, examination is studying how best to utilize currency transaction information and our efforts can be described as a multilevel approach.

First, we have placed in process a system that associates currency transaction information with the tax returns that are selected for examination and with the returns that are part of our information document-matching program.

Next, and, I might add, a much more difficult part of the process, is to develop a selection system that effectively uses this information to cause returns to be examined.

Therefore, we must be able to discriminate among the large volume of these reports to identify those that have the greatest potential for noncompliance.

Before I describe some of the studies that we have undertaken to do this, let me say that it is difficult to use the CTR as the sole indicator of noncompliance, although it may be a very vital piece of information with respect to a particular case.

Our research efforts in this area have taken a novel approach in trying to solve this problem and to build a return selection system. Traditionally, we have approached building return selection systems using data that appears on filed income tax returns. The studies which I am about to describe focus not only on tax return information, but in a significant way, they also focus on information not appearing on the tax returns and the CTR and the CMIR's are components of that nonreturn information.

We have a Florida tax haven study which is attempting to establish a profile of individuals involved in money laundering so that we can build from this profile a supplemental selection system. Data for this study is being drawn from cases in south Florida involving a major money laundering scheme.

The case involved a Florida tax preparer arrested for various currency and narcotics violations. As a result of that arrest, a large volume of client files and related information was acquired by the Internal Revenue Service. A preliminary reconstruction of income using currency monetary instrument reports [CMIR's] that were filed by this preparer indicates more than $38 million was laundered by his office through a tax haven and returned to Florida during 1982 and the first 5 months of 1983.

Examinations of clients to date indicate that two basic laundering schemes were utilized. One of the methods used involved the physical delivery of cash to the local agency of a foreign bank for the purpose of wiring these funds to a foreign country. Wiring funds, however, established a paper trail due to the Bank Secrecy Act reporting requirements.

Therefore, to circumvent this, in a majority of the cases, the preparer personally transported the cash in a chartered plane to the tax haven country. Of course, this represents noncompliance with the CMIR provisions which should have been reported to the Customs Service.

Data was collected from the examination of those clients who had failed to report part or all of their income. Of approximately 135 cases closed to date, examiners have discovered more than $49.5 million in unreported income and proposed in excess of $37 million in additional tax and penalties.

CTR's were used in conjunction with other sources of information, such as CMIR's and bank records, to uncover about $16 million of the unreported income. However, the CTR's alone accounted for less than $500,000 of the unreported $16 million.

This indicates that CTR's are a valuable tool when used with other information sources. The CTR alone in many of these cases did not assure that the person was an underreporter or that the amount represented unreported income.

We are now attempting to use data from the study to identify individuals who possess the same characteristics as those found to be concealing income in the Florida case. This would give the Service an additional return selection system for identifying returns in need of examination.

The tax haven offshore banking project has been established jointly by the examination and criminal investigation functions to consolidate the various types of third-party information which is associated with tax haven activity. Data from this project will be used to select cases for a controlled study which will evaluate and combine information from third-party sources, including CTR's, to test the effectiveness of this technique in identifying non-compli

ance.

Other cases will be referred to the field as the result of civil leads provided to examination by the criminal investigation division. These leads will be tracked and the results analyzed to detect common patterns of money-laundering techniques. These efforts

are still ongoing and we are not yet certain how well they will work for us.

Finally, I would like to point out an inconsistency between the summons authority available under title 26 and title 31 which does have an impact on our ability to enforce title 31.

Presently, we cannot honor the financial institutions' requests for a summons in connection with a compliance check, nor can we summons or subpoena records from an institution that refuses to cooperate. Cooperating financial institutions frequently request a summons as a means of protecting themselves from possible suits by their clients.

In title 26 examinations, we issue such a summons to the requesting bank. Without such authority under title 31, institutions who really want to cooperate with the Service refuse to do so for their own legal protection.

Furthermore, if we are conducting a title 31 examination and a financial institution refuses to provide us with appropriate books and records to reach a determination, we have to stop our examination and forward that incomplete case to Treasury for appropriate action. We feel that this is wasteful of our resources and is not administratively effective.

In summary, the real benefit to be derived from the information required by the act from the standpoint of civil tax enforcement is the use of that data in identifying returns in need of examination. I hope I have emphasized the extent of examination's efforts in developing a selection system using Bank Secrecy Act information as an integral part of our efforts to improve voluntary compliance. I would like to thank the subcommittee for permitting me to provide this information.

Thank you, Mr. Chairman.

[The prepared statement of Mr. Woodard can be found in the appendix.]

Chairman ST GERMAIN. Thank you, Mr. Woodard.

Now we will hear from Francis M. Passarelli, who is the Acting Director of the Office of Examination and Supervision, with the Federal Home Loan Bank Board.

Mr. Passarelli, we will put your entire statement into the record. You may proceed.

STATEMENT OF FRANCIS M. PASSARELLI, ACTING DIRECTOR, OFFICE OF EXAMINATION AND SUPERVISION, FEDERAL HOME LOAN BANK BOARD

Mr. PASSARELLI. Thank you. Mr. Chairman and distinguished members of the subcommittee, I am Francis Passarelli, Acting Director, Office of Examinations and Supervision of the Federal Home Loan Bank Board.

Accompanying me are Harry Quillian, Acting General Counsel of the Bank Board, and Rosemary Stewart, Director of the Board's Office of Enforcement.

We are here today to testify on the Board's effort to carry out its responsibility under the Bank Secrecy Act, which I will sometimes refer to as BSA. The Board recognizes the importance of this act and in my testimony I will discuss both our BSA activities and our

plans to strengthen them. I will then address issues the subcommittee raised with regard to other laws and proposed legislation.

One of the principal ways that we have carried out our Bank Secrecy Act responsibilities is by having our examiners review compliance with the act in their regular examinations. Our Bank Secrecy Act examination objectives and procedures were developed with other Federal financial regulatory agencies, the Treasury De partment and the Government Accounting Office.

In 1982, in order to focus our limited examination resources on the most urgent targeted areas, mandatory usage of the EOP was suspended. But the EOP, examination work papers and BSA check list remain the principal guidance to examiners. Examiners continue to be responsible for meeting examination objectives.

Whenever necessary, examiners must advise institution managers of their responsibilities under the BSA regulations. The Board's supervisory agents at the 12 Federal home loan banks are responsible for taking supervisory action when necessary to obtain compliance with the act.

We refer violations that warrant civil or criminal penalties to the Treasury Department as soon as they are discovered by bank system examiners. In addition, we transmit summary reports of all violations twice a year to the Treasury Department.

Moreover, pursuant to the BSA and its regulation, OES may recommend to the Treasury Department that it impose civil penalties and make referrals for possible criminal investigations.

In 1985, we found 46 Bank Secrecy Act violations in a total of 10 of the 1,808 institutions we examined. Forty violations concerned failure to file currency transaction reports and six concerned failure to maintain the required list of exempt customers.

In all cases, we required corrective action. In one instance, we referred the matter to Treasury with a recommendation for a civil penalty and criminal investigation.

We hope that the small number of violations that we have detected in our examination process indicates that most institutions we regulate comply with the Bank Secrecy Act. However, we are taking action to strengthen our examination and supervisory process in general, and those relating to

Chairman ST GERMAIN. Excuse me. Mr. Passarelli, I hope you're going to do more than hope.

Mr. PASSARELLI. We intend to, sir.

Chairman ST GERMAIN. That's a pretty weak word.

Mr. PASSARELLI. We intend to, sir. I would like to tell you some of the actions we've taken and are taking.

Because the Bank Board recognized that its examination staff was too small to handle the increased demands we have recently faced, on July 6, 1985, the Board transferred its 747 examiners to the 12 district banks and gave the banks responsibility for conducting examinations under policies and procedures established by the Board.

Following this reorganization, the Federal home loan banks expanded their examination staffs at the direction of the Federal Home Loan Bank Board Chairman Gray

By December 31, 1985, there were 1,003 examiners in the banks, a more than one third increase over the July 6 figure. Moreover,

the Chairman's goal is to reach 1,250 examiners by July 1, 1986, which will be a total increase of two-thirds in 1 year.

To ensure that substantial and material violations of law are corrected promptly, the Chairman has repeatedly directed bank system staff to take aggressive supervisory action.

On August 9, 1985, he issued a memorandum requiring that supervisory correspondence to depository institutions be firm and precise, and that formal enforcement action be initiated where violations or unsound practices cannot be resolved expeditiously.

On August 23, 1985, the Chairman called for prompt, vigorous use of formal enforcement tools for material violations and deficiencies, and required reporting to Washington whenever such enforcement was not deemed immediately appropriate.

On February 12, 1986, he directed the immediate reporting of significant problems detected during examinations.

All new examiners are required to attend the new examination training school which includes instructions on the Bank Secrecy Act.

In addition, we have provided all 12 Federal Home Loan Banks with a videotape designed in part at the board. The videotape is intended for the newly hired examiner and as refresher training for examination and supervisory staff.

During 1985, and thus far in 1986, we have issued a number of notices about the Bank Secrecy Act to institutions in the Federal Home Loan Bank System, including memoranda describing the responsibility of independent public accountants under the Bank Secrecy Act; directing each institution to establish Bank Secrecy Act employee training programs; providing information on the new role of the Internal Revenue Service in reviewing exemption lists and approving or denying individual requests for exemptions; and distributing amendments to the Bank Secrecy Act regulations.

The Federal Home Loan Bank Board has worked closely with the Department of Justice to design a revised criminal referral form to obtain information the Department needs for criminal investigations.

In 1985, board examiners filed 150 of these forms and insured institutions voluntarily filed 652.

Beginning in 1986, FSLIC-insured institutions have been required to report known or suspected criminal acts. As a result, in the first 3 months of 1986, examiners filed 27 referral forms and the institutions themselves filed 911. The Bank Board has actively participated in the Attorney General's Bank Fraud Working Group and established contacts throughout the country to communicate quickly and directly with the Justice Department.

In addition, the Board is participating in the Justice Department's new tracking system for agency criminal referrals. In addition, we are revising our Bank Secrecy Act examination procedures. We are also writing Bank Secrecy Act supervisory procedures. We are also drafting additional guidance to help auditors detect and report money laundering activities and are distributing to the staff and to insured institutions several recent issuances from the Department of the Treasury.

Chairman ST GERMAIN. Mr. Passarelli, let me ask you this. You're aware of the GAO report to us.