SAR Privilege Protects U.S. Bank’s Internal Investigation Policies and Procedures

In a broad interpretation of the Suspicious Activity Report (SAR) privilege, a Washington state appellate court ruled that the privilege precludes disclosures of a bank’s policies and procedures for investigating suspicious activity and its specific internal investigations into wrongful conduct. Norton v. U.S. Bank Nat’l Ass’n, 324 P.3d 693 (WaSAR Reportsh. Ct. App. 2014). You may read the opinion here.

A U.S. Bank employee left to start an investment company, which later turned out to be a Ponzi scheme using several accounts at U.S. Bank. The plaintiffs invested in the Ponzi scheme, lost $11 million, and later sued U.S. Bank for breaches of fiduciary duty, fraud, and several other causes of action.

In discovery, the plaintiffs sought all documents related to U.S. Bank’s internal investigation and documents, including policies, generally related to U.S. Bank’s internal monitoring and investigations to detect money laundering. U.S. Bank resisted the discovery on grounds that the SAR privilege protects general and specific internal investigation documents from civil discovery. The Washington appellate court agreed and reversed the trial court’s denial of the privilege.

The SAR privilege arises from the Bank Secrecy Act, 31 U.S.C. § 5318, and its implementing regulations. The confidentiality provisions of 12 CFR § 21.11(k) constitute an “unqualified discovery and evidentiary privilege.” The SAR privilege covers not only the Suspicious Activity Report, but also any information that would reveal whether such a report exists.

In Norton, the state appellate court held that simply redacting explicit references to the existence of a SAR is insufficient to enforce the privilege. The court interpreted the SAR privilege broadly, finding that federal statutes require banks to establish internal policies, procedures, and controls to detect and report money laundering, and that these policies are intertwined with banks’ obligation to report suspicious activity. As such, the court ruled that “discovery into these matters will produce documents suggesting” that the bank either filed or considered filing a Suspicious Activity Report.

The court held that U.S. Bank was not required to produce its internal investigation policies and procedures generally or with specific reference to the Ponzi scheme perpetrated by its former employee. According to the court, “internal reports and methods used to investigate suspicious activity are precisely the type” of supporting documentation that the SAR privilege covers.

SAR Privilege Protects Some, But Not All, Wells Fargo Documents

The USDC for the Middle District of Florida ruled that the Suspicious Activity Report (SAR) Privilege protected evaluative investigative reports and communications about those reports, but did not protect the underlying transactional documents on which the bank, Wells Fargo, based its suspicious activity report.  Slide1Wiand v. Wells Fargo Bank, 2013 WL 5925545 (M.D. Fla. Oct. 25, 2013).  You may access the opinion here.

The SAR Privilege

Federal law requires financial institutions to file a suspicious activity report notifying the government of suspected criminal activity.  31 U.S.C. § 5318.  And federal regulations impose an evidentiary privilege that protects from compelled disclosure all suspicious activity reports, or SARs, and “any information that would reveal the existence of a SAR.”  12 CFR § 21.11(k).

The privilege does not protect the underlying facts, transactions, or documents on which a SAR is based. Courts therefore hold that the SAR privilege “does not shield from discovery reports, memoranda, or underlying transactional documents generated by a bank’s internal investigation procedures.”

Wells Fargo Arguments and Court’s Ruling

Wells Fargo argued that the SAR privilege also protected its materials prepared to detect suspicious activity regardless whether it later filed a SAR.  The court evaluated this argument and divided the putatively privileged documents into three categories for consideration: (1) transaction documents related to bank accounts; (2) internal bank emails and reports; and (3) communications between Wells Fargo and another financial institution.

The court ruled that the SAR privilege did not protect the transaction documents.  Importantly, however, the court distinguished between truly transactional documents, which the privilege did not cover, and “internal reports of an evaluative nature,” which the privilege did cover.

Following this distinction, the court ruled that the SAR privilege did not cover most of Wells Fargo’s internal emails and reports, only a small portion of a page that “could be considered a report of an evaluative nature intended to comply with federal reporting requirements.”

The court held that the SAR privilege protected Wells Fargo’s external communications with another financial institution because those communications “reflect material that could be considered as a report of an evaluative nature intended to comply with federal reporting requirements.”

SDNY Adopts Bank Examination Privilege for FHFA Communications with Fannie Mae and Freddie Mac

In a matter of first impression, the US District Court for the Southern District of New York adopted the bank examination privilege to protect from compelled discovery communications between the Federal Housing Finance Agency (FHFA) and the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).  FHFA v. JPMorgan Chase & Co., 2013 WL 5660247 (S.D.N.Y. Oct. 16, 2013).  You may access the opinion here.

FHFA,fhfa as conservator of Fannie Mae and Freddie Mac, sued several financial institutions involved with the packing, marketing, and sale of residential mortgage-backed securities purchased by Fannie Mae and Freddie Mac.  FHFA asserted the bank examination privilege to withhold from discovery approximately 15,000 documents.  The financial institutions argued that the privilege did not apply because Fannie Mae and Freddie Mac are not banks and the FHFA is not a bank regulator.

The court first reviewed the rationale behind the common-law bank examination privilege.  Effective practical regulation requires bank regulatory agencies and their regulated entities to communicate openly, and the privilege encourages banks to have candid and open communications with its regulatory overseers.  And public disclosure of bank–regulator communications may lead to public scrutiny of an entity’s soundness—a consequence that regulators seek to avoid.

The court found no precedent addressing whether the federal common-law bank examination privilege applied to the FHFA.  But in this matter of first impression, the court held that the FHFA may assert the bank examination privilege because its regulatory oversight of Fannie Mae and Freddie Mac implicates the same concerns that justify the bank examination privilege in the banking regulatory sphere.

The court determined that FHFA’s oversight duties overlap the oversight duties of bank regulators.   And the need for Fannie Mae and Freddie Mac to communicate freely with the FHFA mimics banks’ need for open communications with their regulators.  And the need for public confidence in the federal lending system is as strong as the private financial system.  In short, “considerations of economic stability counsel in favor of a regulatory regime in which FHFA can informally and confidentially discuss issues of capitalization and liquidity with [Fannie Mae and Freddie Mac] in a privileged manner rather than through formal comment and adjudication.”

The court rejected the financial institutions’ argument that FHFA is not a bank regulator and Fannie Mae and Freddie Mac are not banks, stating that to do so elevates semantics over substance.  And to decide whether to adopt the privilege in the FHFA setting “on the sole ground that a judge at some point in the past named this privilege the ‘bank’ examination privilege, without looking to the principles underlying the privilege and their application to the facts at hand, would run counter to the standard enunciated in Rule 501 and in the caselaw.”